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INDEX

 

COMPUMED, INC. AND SUBSIDIARIES

FINANCIAL INFORMATION
BALANCE SHEETS
COMPUMED, INC.
		June 30, 2006			September 30, 2005
		(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents			203,000			281,000
Marketable securities, at fair market value			377,000			290,000
Accounts receivable, less allowance of $26,000			388,000			323,000
(June 2006 and September 2005)
Inventory			23,000			31,000
Prepaid expenses and other current assets			23,000			18,000
TOTAL CURRENT ASSETS			1,014,000			943,000
PROPERTY AND EQUIPMENT
Machinery and equipment			1,242,000			1,252,000
Furniture, fixtures and leasehold improvements			78,000			78,000
Equipment under capital leases			203,000			183,000
			1,523,000			1,513,000
Accumulated depreciation and amortization			(1,313,000	)		(1,273,000	)
TOTAL PROPERTY AND EQUIPMENT			210,000			240,000
OTHER ASSETS
Patents, net of accumulated amortization of $7,000 (June 2006)			111,000			77,000
and $5,000 (September 2005)
Other assets			13,000			13,000
TOTAL OTHER ASSETS			124,000			90,000
TOTAL ASSETS			1,348,000			1,273,000
LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES
Accounts payable			127,000			159,000
Accrued liabilities			116,000			148,000
Current portion of capital lease obligations			37,000			33,000
TOTAL CURRENT LIABILITIES			280,000			340,000

Capital lease obligations, less current portion			98,000			126,000
STOCKHOLDERS' EQUITY
Preferred Stock, $.10 par value - authorized 1,000,000 shares
Preferred Stock- Class A $3.50 cumulative convertible voting -
issued and outstanding - 8,400 shares			1,000			1,000
Preferred Stock- Class B $3.50 cumulative convertible voting -
issued and outstanding - 300 shares			-			-
Common Stock, $.01 par value - authorized 50,000,000 shares,
issued and outstanding - 24,171,467 shares (June 2006)
issued and outstanding - 22,920,609 shares (September 2005)			243,000			230,000
Additional paid in capital			33,612,000			33,154,000
Accumulated deficit			(32,861,000	)		(32,589,000	)
Accumulated other comprehensive income			(6,000	)		17,000
Deferred stock compensation			(19,000	)		(6,000	)
TOTAL STOCKHOLDERS' EQUITY			970,000			807,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY			1,348,000			1,273,000
See notes to condensed financial statements.

 

 

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STATEMENTS OF OPERATIONS (UNAUDITED)

COMPUMED, INC.

		Three Months Ended						Nine Months Ended
		June 30						June 30
		2006			2005			2006			2005
REVENUE FROM OPERATIONS
ECG services			404,000			449,000			1,264,000			1,299,000
ECG product and supplies sales			54,000			53,000			157,000			394,000
OsteoGram (R) sales and services			20,000			52,000			253,000			72,000
			478,000			554,000			1,674,000			1,765,000
COSTS AND EXPENSES
Costs of ECG services			131,000			149,000			421,000			441,000
Cost of goods sold-ECG			41,000			28,000			116,000			297,000
Cost of goods sold - OsteoGram (R)			4,000			6,000			7,000			9,000
Selling expenses			95,000			74,000			318,000			204,000
Research & development			61,000			78,000			228,000			195,000
General and administrative expenses			262,000			263,000			831,000			763,000
Depreciation and amortization			17,000			26,000			52,000			62,000
			611,000			624,000			1,973,000			1,971,000
OPERATING LOSS			(133,000	)		(70,000	)		(299,000	)		(206,000	)
Interest Income and dividends			7,000			4,000			41,000			12,000
Other miscellaneous income			-			-			-			8,000
Realized gain on marketable securities			-			19,000			-			19,000
Interest expense			(4,000	)		(4,000	)		(14,000	)		(10,000	)
NET LOSS			(130,000	)		(51,000	)		(272,000	)		(177,000	)
NET LOSS PER SHARE (Basic and diluted)			(0.01	)		(0.00	)		(0.01	)		(0.01	)
Weighted average number of common
shares outstanding			24,154,608			21,109,519			23,542,897			20,438,626

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STATEMENTS OF CASH FLOWS (UNAUDITED)
COMPUMED, INC.
		Nine Months Ended June 30,
		2006			2005
OPERATING ACTIVITIES:
Net loss			(272,000	)		(177,000	)
Net adjustments to reconcile net loss to net cash used in operating activities:
Realized gain on marketable securities			-			(19,000	)
Amortization of deferred stock compensation			5,000			1,000
Depreciation and amortization			52,000			62,000
(Increase) in accounts receivable			(65,000	)		(18,000	)
Decrease in inventory and prepaid expenses			3,000			11,000
(Decrease)/Increase in accounts payable and other liabilities			(44,000	)		1,000
NET CASH USED IN OPERATING ACTIVITIES			(321,000	)		(139,000	)
CASH FLOW FROM INVESTING ACTIVITIES:
Proceeds from selling of marketable securities			-			55,000
Investments in purchase of marketable securities			(110,000	)		(47,000	)
Purchase of other asset			(34,000	)		(14,000	)
Purchase of property, plant and equipment			(3,000	)		(27,000	)
NET CASH USED IN INVESTING ACTIVITIES			(147,000	)		(33,000	)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock option			162,000			93,000
Issuance of stock to Dutchess per agreement			252,000			171,000
Payments on capital lease obligations			(24,000	)		(13,000	)
NET CASH PROVIDED BY FINANCING ACTIVITIES			390,000			251,000
NET (DECREASE)/INCREASE IN CASH			(78,000	)		79,000
CASH BEGINNING OF PERIOD			281,000			62,000
CASH AT END OF PERIOD			203,000			141,000
SUPPLEMENTAL DISCLOSURES:
Interest paid			14,000			10,000
Disposal of fixed asset			13,000			99,000

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                                             For  The  Nine  Months  Ended
                                        June  30,  2006        June 30, 2005
                                        -----------------    -----------------
Risk  free  interest  rate               4.47% to 5.11%        4.28% to 4.73%
Stock  volatility  factor                      37%               17% to 33%
Weighted  average  expected  option  life   2 to 10 years         10 years
Expected  dividend  yield                      None                 None

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The pro forma net loss and loss per share had the Company accounted for the options using FAS 123 would have been as follows

		Three Months Ended June 30,						Nine Months Ended June 30,
		2006			2005			2006			2005
Net loss as reported			(130,000	)		(51,000	)		(272,000	)		(177,000	)
Basic and diluted loss per share as reported			(0.01	)		(0.00	)		(0.01	)		(0.01	)
Add: stock based employee compensation cost			9,000			0			12,000			0
included in determination of net loss reported
Deduct: stock-based employee compensation cost			(41,000	)		(21,000	)		(101,000	)		(57,000	)
that would have been included in the determination
of net loss if the fair value method had been applied
to all awards
Pro forma net loss if the fair value based method			(169,000	)		(72,000	)		(361,000	)		(234,000	)
had been applied to all awards
Basic and diluted pro forma loss per share if the
fair value based method had been applied for
all awards			(0.01	)		(0.00	)		(0.02	)		(0.01	)

 

 

	2006		2005
		Weighted-		Weighted-
		Average		Average
		Exercise		Exercise
	Shares	Price	Shares	Price
Options outstanding, beginning of period	6,571,934	0.25	6,437,217	0.22
Options exercised	(825,441)	0.20	(1,007,454)	0.09
Options granted	360,000	0.64	995,000	0.24
Options forfeited/canceled	(491,665)	0.28	(10,879)	0.71
Options outstanding, end of period	5,614,828	0.28	6,413,884	0.25
Options exercisable, end of period	4,624,834	0.26	4,145,559	0.26

 

		Weighted
	Weighted	Average	Number	Weighted
	Average	Remaining	Average	Average
	Number	Contractual	Exercise	Number
Range of Exercise Prices	Outstanding	Life	Price	Exercisable
$0.000000 - $0.425000	4,407,143	7.24	$0.17	3,402,149
$0.425100 - $0.850000	1,176,435	4.88	$0.66	831,435
$0.850100 - $1.275000	31,250	1.39	$1.15	31,250
	5,614,828	6.71	$0.28	4,264,834

 

PER SHARE DATA

 

The Company reports its earnings (loss) per share in accordance with Statement of Financial Accounting Standards No.128, "Accounting for Earnings Per Share" ("FAS 128"). Basic loss per share is calculated using the net loss divided by the weighted average common shares

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outstanding. Shares from the assumed conversion of outstanding warrants, options and the effect of the conversion of the Class A Preferred Stock and Class B Preferred Stock are omitted from the computations of diluted loss per share because the effect would be anti-dilutive.

 

NOTE B - OTHER AGREEMENTS

 

On February 25, 2004, the Company entered into an Investment Agreement with Dutchess Private Equities Fund. That agreement provides that, following notice to Dutchess, the Company may sell to Dutchess up to $5 million in shares of its Common Stock for a purchase price equal to 95% of the average of the three lowest closing bid prices on the Over-the-Counter Bulletin Board of its Common Stock during the five day period following that notice. The number of shares that the Company is permitted to sell pursuant to the Investment Agreement is either: (A) two hundred percent of the average daily volume of its Common Stock for the ten trading days prior to the applicable sale notice, multiplied by the average of the three daily closing best bid prices immediately preceding the day the Company issues the notice, or (B) $25,000; provided that in no event will the sale be more than $1,000,000 with respect to any single sale.

 

Dutchess' obligation to purchase the Company’s Common Stock is contingent upon certain closing conditions. Such conditions relate to the Investment Agreement and include: (i) that the Company’s representations and warranties are true and correct as of the funding date, (ii) that the Company has performed all of its covenants, agreements and conditions required to be performed , (iii) that trading of the Company’s Common Stock has not been suspended, (iv) that no statute, rule, regulation, executive order, decree, ruling or injunction is in force against the transactions contemplated in the Investment Agreement, (v) that no pending or threatened litigation exists, and (vi) that the SEC has declared effective a registration statement covering the shares to be purchased by Dutchess.

 

On October 28, 2005, the Company declared a dividend of one Common Stock Purchase Right for each outstanding share of common stock. The dividend is payable to holders of record at the close of business on August 1, 2005. Each Right entitles the registered holder to purchase shares of common stock at a purchase price of $0.40, subject to adjustment.

 

Initially, the Rights will not be exercisable, certificates for the Rights will not be issued and the Rights will automatically trade with the Company’s Common Stock. Until the close of business on the earlier of (i) the tenth day following the public announcement that a person or group of affiliated or associated persons ("Acquiring Person") other than the Company, its subsidiary or any employee benefit plan or employee stock plan ("Exempt Person") has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the Company’s outstanding Common Stock or (ii) the tenth business day following the commencement by any person (other than an Exempt Person) of, or the announcement of the intention to commence, a tender or exchange offer that would result in the ownership of 15% or more of the Company’s outstanding Common Stock (the earlier of such dates in clauses (i) and (ii) being called the "Distribution Date"), the Rights will be evidenced, with respect to any of the Common Stock certificates outstanding as of August 1, 2005, by such Common Stock certificate, together with a copy of the Summary of Rights.

 

The Rights are not exercisable until the Distribution Date. The Rights will expire at the close of business on October 28, 2009, unless redeemed or exchanged.

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

 

SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS

 

This Report on Form 10-QSB contains forward-looking statements, including, without limitation, statements concerning our possible or assumed future results of operations. These statements are preceded by, followed by or include the words "believes," "could," "expects," "intends," "anticipates," or similar expressions. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons including, but not limited to, product and service demand and acceptance, changes in technology, ability to raise capital, the availability of appropriate acquisition candidates and/or business partnerships, economic conditions, the impact of competition and pricing, capacity and supply constraints or difficulties, government regulation and other risks described in this report. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made, and our future results, levels of activity, performance or achievements may not meet these expectations. We do not intend to update any of the forward-looking statements after the date of this document to conform these statements to actual results or to changes in our expectations, except as required by law.

 

OVERVIEW

 

Our traditional core business is providing remote ECG (electrocardiogram) interpretation services to medical facilities that may not have access either to trained physicians that can interpret ECG results or to self-interpreting ECG equipment. Our customers are typically correctional facilities, ambulatory surgery centers, occupational health clinics and physician offices. Although self-interpreting ECG equipment is widely available, many of our customers like the optional feature of automatically sending their ECG results to one of our cardiologists for an overread when the results are abnormal. This overread feature is a key advantage that enables us to market our services in segments of the market where physicians may not be available on a routine basis. We are evaluating new opportunities for our ECG business; however, we could lose customers who choose to receive services from a competitor or who purchase a self-interpretive machine and no longer need our ECG interpretations. If we were to lose existing customers, they may be difficult to replace, and that could have a material adverse impact on our operations and financial condition.

 

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Our other business is the development and marketing of medical imaging software tools that automatically make accurate and precise measurements to diagnose bone disease. Our target markets for these products are hospitals, imaging centers and orthopedic office practices. Our initial product, the OsteoGram, is an automated system for the rapid screening, diagnosis and monitoring of osteoporosis, a disease that affects more than 200 million people worldwide.

 

Osteoporosis is a "silent disease" that costs the U.S. healthcare system over $17 billion annually contrasted to the $6 billion spent annually on breast cancer. Fifty percent of all women will suffer an osteoporosis-related fracture in their lifetime, and Medicare is currently scrutinizing methods to lower the costs of fighting this largely preventable disease by working with the National Committee for Quality Assurance to stimulate point-of-care testing of "at risk" patients. We believe that convenient, low-cost methods of screening and diagnosing will become increasingly desirable as hospitals comply with recent initiatives directing them to test for and treat this insidious disease.

 

The OsteoGram was originally marketed as a film-based product that utilized a standard hand x-ray film that is digitized on a desktop scanner. The image is then analyzed on a personal computer by means of the patented OsteoGram software. This system is still marketed to small hospitals, clinics and physician's offices. The DICOM version of the OsteoGram was developed to take advantage of the growing market for digital, or filmless, x-ray equipment. DICOM is the information standard that allows digital imaging equipment to interconnect, enabling clinicians to readily move, archive and retrieve images and diagnostic information over networks. By residing on the workstations of these advanced digital systems, the OsteoGram software can automatically capture and analyze images directly from either the x-ray equipment or the network. We license our DICOM OsteoGram software to manufacturers of digital x-ray and network equipment to place at the point-of-sale. In addition, we enlist dedicated imaging distributors to sell our products in the after sale market.

 

In April of 2006 we announced a one-year, exclusive licensing agreement with Kodak Electronics Products Shanghai Co., LTD (KEPS) that enables KEPS to integrate and market our OsteoGram software in conjunction with their digital (filmless) x-ray platforms sold in China. KEPS has one of the largest installed bases of digital radiography systems in China, and currently markets its products via a direct sales organization, as well as a comprehensive nationwide network of medical imaging distributors. This is an important agreement, since China is the world’s largest osteoporosis market. The disease poses an increased public health threat for Asian women, mainly due to the lack of calcium in the traditional Asian diet. According to China's 2000 national census, approximately 88 million of its citizens suffer from primary osteoporosis, making China the nation with the world's highest number of osteoporosis patients. The annual medical cost for those affected by the disease is estimated to be about 15 billion Yuan (1.8 billion US Dollars), a figure that does not take into account the significant strain osteoporosis incurs on China's national healthcare program.

 

Our development team devoted most of their time in this quarter working closely with KEPS to fully integrate our software into their own operating system. Unlike other software integration projects we have participated in, full integration entails breaking down the software into modules that can be manipulated by the host workstation plus the development of a new user interface. We expect the project to be completed before the end of August, and that shipments will begin immediately thereafter. We are confident that China represents a large market opportunity for the OsteoGram, and that KEPS is the best partner for us going forward.

 

We also finished the integration of the OsteoGram into the newest version of the OREX CR software system. Our chief technology officer worked diligently with the OREX team to accomplish the task, and we expect sales activity with OREX to pick up in the fourth quarter. OREX is a wholly owned subsidiary of the Kodak Health Group. The OREX CR is a cost-effective desktop unit with strong appeal to the office-based orthopedic market. In the effort to drive down the costs associated with osteoporosis, Medicare’s initiatives have targeted point-of-care settings to test or treat this insidious disease.

 

Our ECG business remains a solid contributor. Although we lost three contracts during the first nine months of fiscal year 2006 with small correctional healthcare providers, ECG placements continued with the larger, growing concerns, such as CMS and Wexford. Rental revenues continued on the downward trend; however, ECG transmissions increased over the nine-month period. We were pleased to renew contracts with the GEO Group and the state departments of corrections in Iowa, Nebraska, Wyoming, Nevada and the City and County of San Francisco in June and July 2006. In addition, we are currently exploring ways to broaden our offering in the telemedicine field.

 

RESULTS OF OPERATIONS FOR THE QUARTER AND THE NINE MONTHS ENDED JUNE 30, 2006 COMPARED TO THE SAME PERIOD OF FISCAL 2005.

 

Revenues from ECG sales and services decreased by 9% for the third quarter of fiscal 2006 to $458,000 from $502,000 in fiscal 2005, due to contract cancellations of three correctional healthcare providers. During the nine months ended June 30, 2006 revenues from ECG sales and services decreased by 16% to $1,421,000 from $1,693,000 for the same period in 2005, due to the one-time sale of ECG equipment sold to New York Department of Corrections in fiscal 2005. Revenues from the OsteoGram(R) sales and services for the third quarter of fiscal 2006 decreased by 62% to $20,000 from $52,000 in fiscal 2005, due to slower than expected product launch and ramp-up by our OEM partners, and for the nine months ended June 30, 2006 increased by 251% to $253,000 from $72,000 for the same period in 2005, due to the shipments to OREX Computed Radiography and FUJIFILM Medical Systems USA.

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Cost of services and goods sold consists of the costs of ECG services provided, supplies, electrocardiograph equipment sold and OsteoGram(R) systems sold.

 

Costs of services of ECG for the third quarter of fiscal 2006 decreased by 12% to $131,000 from $149,000 in fiscal 2005, and for the nine months ended June 30, 2006 decreased by 5% to $421,000 from $441,000 for the same period in 2005, due to decreased communication expenses.

 

Cost of goods sold of ECG for the third quarter of fiscal 2006 increased by 46% to $41,000 from $28,000 for the same period of fiscal 2005, and during the nine months ended June 30, 2006 decreased by 61% to $116,000 from $297,000 for the same period in 2005. The costs of goods variation were caused by the variable equipment sales during these periods.

 

The cost of goods sold for OsteoGram(R) for the third quarter of fiscal 2006 decreased by 33% to $4,000 from $6,000 for the same period in 2005, for the nine months ended June 30, 2006 decreased by 22% to $7,000 from $9,000 for the same period in 2005 due to sales that do not include computer hardware.

 

Selling expenses for the third quarter of fiscal 2006 increased by 28% to $95,000 from $74,000 in fiscal 2005, and for the nine months ended June 30, 2006 increased by 56% to $318,000 from $204,000 for the same period in 2005. The increase was due primarily to the hiring of the Vice President Sales for the OsteoGram(R) business.

 

General and administrative expenses for the third quarter of fiscal 2006 decreased by 0.38% to $262,000 from $263,000 in fiscal 2005, and for the nine months ended June 30, 2006 increased by 9% to $831,000 from $763,000 for the same period in 2005, mainly due to retaining the investor relations firm Porter LeVay and Rose, Inc. in May 2005.

 

Research and development costs for the third quarter of fiscal 2006 decreased by 22% to $61,000 from $78,000 in fiscal 2005, and for the nine months ended June 30, 2006 increased by 17% to $228,000 from $195,000 for the same period in 2005. We hired a Vice President of Engineering as a full time employee, thus terminating his consulting services. This resulted in the reduction of the consulting fees during the third quarter of fiscal 2006 and the increase of salary expenses in the nine months ended June 30, 2006.

 

Interest income and dividends for the third quarter of fiscal 2006 increased by 75% to $7,000 from $4,000 in fiscal 2005, and for the nine months ended June 30, 2006 increased by 242% to $41,000 from $12,000 for the same period in 2005, due to increased investments in marketable securities.

 

There were no other miscellaneous income for the three and nine months ended June 30, 2006. As for fiscal 2005, there was none in the third quarter and $8,000 in the nine months ended June 30, 2005. The increase was due to a reversal of a reserve related to operating business expenses.

 

Interest expense for the third quarter of fiscal 2006 and 2005 remains the same at $4,000. For the nine months ended June 30, 2006, it was increased by 40% to $14,000 from $10,000 for the same period in 2005, due to increase in ECG equipment financing.

 

Net loss for the third quarter of fiscal 2006 increased by 155% to $130,000 from $51,000 in fiscal 2005, and for the nine months ended June 30, 2006 increased by 54% to $272,000 from $177,000 for the same period in 2005, due to decreased revenue in both ECG and OsteoGram businesses described above.

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

At June 30, 2006, we had $580,000 in cash and marketable securities, as compared to a balance of $571,000 at September 30, 2005, a net increase of $9,000, due to funds raised through Dutchess Private Equities Fund and exercise of stock options by directors and employees.

 

The purchases of property, plant, and equipment during the third quarter of 2006 were $3,000 compared to $27,000 for the same period in fiscal 2005.

 

We have historically used existing cash and readily available marketable securities balances to fund operating losses and capital expenditures. We also raise funds through the sale of Common and Preferred stock issuances and proceeds from the exercise of stock options and warrants.

 

CAPITAL COMMITMENTS

 

We lease our corporate offices on an annual basis, at a monthly rental of $11,822 per month with 3% annual increase.

 

We entered into a long-term agreement with John McLaughlin effective November 2, 2002 through September 30, 2004. This agreement provides a base salary of $150,000 per year and a bonus up to $150,000 based on performance factors including revenue, profit and accomplishment of certain key milestones. In addition, Mr. McLaughlin received standard employee options to purchase 50,000 shares of Common Stock at an exercise price of $0.20 per share upon acceptance of the agreement. On September 24, 2004, the Board passed a resolution to extend this contract for an additional year to 2005. On September 9, 2005 the Board passed a resolution to continue Mr. McLaughlin at a monthly salary of $14,500 starting October 1, 2005.

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Each of our Directors receives an annual Board of Directors fee of $12,000, which is paid to each Director in equal monthly installments. The Chairman receives an additional $4,800. In addition to the Board of Directors fee, Directors receive $1,000 per Board meeting and per Committee meeting when they serve as a member of the Executive, Audit or Compensation Committee. Such amount is reduced to $350 if the Committee meeting is held by teleconference or on the same day as a Board meeting.

 

FINANCING ACTIVITIES

 

On February 25, 2004, we entered into an Investment Agreement with Dutchess Private Equities Fund. That agreement provides that, following notice to Dutchess, we may sell to Dutchess up to $5 million in shares of our Common Stock for a purchase price equal to 95% of the average of the three lowest closing bid prices on the Over-the-Counter Bulletin Board of our Common Stock during the five day period following that notice. The number of shares that are permitted to sell pursuant to the Investment Agreement is either: (A) two hundred percent of the average daily volume of our Common Stock for the ten trading days prior to the applicable sale notice, multiplied by the average of the three daily closing best bid prices immediately preceding the day we issue the notice, or (B) $25,000; provided that in no event will the sale be more than $1,000,000 with respect to any single sale.

 

Dutchess' obligation to purchase our Common Stock is contingent upon certain closing conditions. Such conditions relate to the Investment Agreement and include: (i) that our representations and warranties are true and correct as of the funding date, (ii) that we have performed all of our covenants, agreements and conditions required to be performed by us, (iii) that trading of our Common Stock has not been suspended, (iv) that no statute, rule, regulation, executive order, decree, ruling or injunction is in force against the transactions contemplated in the Investment Agreement, (v) that no pending or threatened litigation exists, and (vi) that the SEC has declared effective a registration statement covering the shares to be purchased by Dutchess.

 

We did not raise any capital in the third quarter of 2006. During the nine months ended June 30, 2006, we sold 375,429 shares of Common Stock to Dutchess Private Equities Fund at an average of $0.68 per share. The gross proceeds was $252,000.

 

PLAN OF OPERATIONS

 

Our business strategy includes an increase OsteoGram(R) revenue through sales to manufacturers of digital x-ray equipment and through sales via domestic and international distributors. We intend to finance this business strategy by using our current working capital resources and cash flows from existing operations, including the ECG and OsteoGram(R) businesses. There can be no assurance that the ECG and OsteoGram(R) sales will be sufficient to offset related expenses We anticipate that our cash flow from operations, available cash, and marketable securities will be sufficient to meet our anticipated cash requirements for at least the next 12 months. However, in certain circumstances we may need to raise additional capital in the future, which might not be available on reasonable terms or at all. If we raise additional capital, we will likely utilize a portion of the $5,000,000 available through the Investment Agreement with Dutchess Private Equities Fund. Failure to raise capital when needed could adversely impact our business, operating results, and liquidity. If additional funds are raised through the issuance of equity or convertible securities, the percentage of ownership of existing stockholders will be reduced. Furthermore, some equity and convertible securities might have rights, preferences or privileges senior to our Common Stock. Our Common Stock is currently traded on the over-the-counter bulletin board, which makes it more difficult to raise funds through the issuance of equity or convertible securities because our Common Stock is thinly traded and those who wish to sell shares of our Common Stock may have difficulty locating buyers. Additional sources of financing may not be available on acceptable terms, if at all.

 

We intend to pursue additional research and/or sub-contractor agreements relating to our development projects. Additionally, we may seek partners and acquisition candidates of businesses that are complementary to our own. Such investments would be subject to our obtaining financing through issuance of debt or other securities. Acquisitions could be dilutive to stockholders.

 

MATERIAL TRENDS AND UNCERTAINITIES

 

The rate of progress in commercializing the DICOM (digital) OsteoGram accelerated at the end of the first quarter of fiscal 2006, mainly due to an order from Orex Computed Radiography. This trend continued in the third quarter as FUJUIFILM Medical Systems USA placed a stocking order. There is no assurance that the increasing OsteoGram sales trend will continue.

 

CRITICAL ACCOUNTING POLICIES

 

Our discussion and analysis of our financial condition and results of operations, including the discussion on liquidity and capital resources, are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we re-evaluate our estimates and judgments, particularly those related to the determination of the estimated recoverable amounts of trade accounts receivable, impairment of long-lived assets, revenue recognition and deferred tax assets. We believe the following critical accounting policies require our more significant judgment and estimates used in the preparation of the financial statements.

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We maintain an allowance for doubtful accounts for estimated losses that may arise if any of our customers are unable to make required payments. Management specifically analyzes the age of customer balances, historical bad debt experience, customer credit-worthiness, and changes in customer payment terms when making estimates of the uncollectability of our trade accounts receivable balances. If we determine that the financial conditions of any of our customers deteriorated, whether due to customer specific or general economic issues, increases in the allowance may be made. Accounts receivable are written off when all collection attempts have failed.

 

We have a significant amount of property, equipment and intangible assets, including patents. In accordance with Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, we review our long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of long-lived and amortizable intangible assets to be held and used is measured by a comparison of the carrying amount of an asset to the undiscounted future operating cash flows expected to be generated by the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds their fair value.

 

We follow the provisions of Staff Accounting Bulletin, or SAB 101, "Revenue Recognition in Financial Statements", for revenue recognition. Under SAB 101, four conditions must be met before revenue can be recognized: (i) there is persuasive evidence that an arrangement exists, (ii) delivery has occurred or service has been rendered, (iii) the price is fixed or determinable and (iv) collection is reasonably assured. In December 2003, the SEC issued Staff Accounting Bulletin SAB No. 104, "Revenue Recognition", which revises and rescinds certain sections of SAB No. 101,”"Revenue Recognition", in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our results of operations, financial position or cash flows.

 

ITEM 3. CONTROLS AND PROCEDURES.

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

Our management evaluated, with the participation of our Chief Executive Officer and Principal Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-QSB. Based on this evaluation, our Chief Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Management's assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance that the control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

There was no change in our internal control over financial reporting during our third quarter of fiscal 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

LIMITATION ON THE EFFECTIVENESS OF CONTROLS

 

Our management, including our Chief Executive Officer and Principal Financial Officer, does not expect that our disclosure controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

 

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

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ITEM 1. LEGAL PROCEEDINGS.

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

On June 27, 2006, we issued 50,000 Class A Common Stock Purchase Warrants to Synthetica (America) Ltd. The warrants have an exercise price of $0.65 and can be exercised at any time prior to the close of business on June 30, 2008.

 

On June 27, 2006, we issued 50,000 Class B Common Stock Purchase Warrants to Synthetica (America) Ltd. The warrants have an exercise price of $0.65 and can be exercised at any time prior to the close of business on June 30, 2008, provided that we have accepted the strategic business plan presented by Synthetica pursuant to a Contractor Agreement between us and Synthetica.

 

On June 27, 2006, we issued 50,000 Class C Common Stock Purchase Warrants to Synthetica (America) Ltd. The warrants have an exercise price of $0.65 and can be exercised at any time prior to the close of business on June 30, 2008, provided that our common stock has had a closing price of $1.00 on any trading day.

 

On June 27, 2006, we issued 100,000 Class D Common Stock Purchase Warrants to Synthetica (America) Ltd. The warrants have an exercise price of $0.65 and can be exercised at any time prior to the close of business on June 30, 2008, provided that the following milestones have been met as determined by our reasonable judgment:

 

 

1)

we achieve $4.8 million in revenues in the fiscal year ending September 30, 2007 from its existing businesses. Revenues from acquisitions that occur after June 30, 2006 will be excluded from the $4.8 million. We will determine our revenues at the same time we file our annual report on Form 10-KSB for the fiscal year ending September 30, 2007 with the Securities and Exchange Commission.

 

 

2)

we complete the acquisition of a business with annual revenues exceeding $2 million per year prior to October 31, 2006. We, in our sole discretion, will consider this milestone met if we complete an acquisition with a minimum of $2 million of assets that meets our strategic goals prior to December 31, 2006.

 

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

 

ITEM 5. OTHER INFORMATION.

 

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

 

NUMBER DESCRIPTION OF EXHIBIT

 

3.1 Certificate of Incorporation (filed as Exhibit 3.1 to the Form S-1 effective May 7, 1992, and incorporated herein by reference).

 

3.2 Certificate of Amendment of Certificate of Incorporation (included as Exhibit 3.1a to the Form S-2/A filed June 28, 1994, and incorporated herein by reference).

 

3.3 Certificate of Amendment of Certificate of Incorporation (included as Exhibit 3.1b to the Form S-2/A filed November 7, 1994, and incorporated herein by reference).

 

3.4 Certificate of Correction of Certificate of Amendment (included as Exhibit 3.1c to the Form S-2/A filed November 7, 1995, and incorporated herein by reference).

 

3.5 By-Laws (included as Exhibit 3.5 to the Form 10-QSB filed February 13, 2004, and incorporated herein by reference).

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3.6 Amendment to By-laws (included as Exhibit 3.6 to the Form 10-QSB filed February 13, 2004, and incorporated herein by reference).

 

4.1 Certificate of Designation of Class A Preferred Stock (included as Exhibit 4.5 to the Form 10-KSB filed December 29, 1995, and incorporated herein by reference).

 

4.2 Certificate of Designation of Class B Preferred Stock (included as Exhibit 4.6 to the Form 10-KSB filed December 29, 1995, and incorporated herein by reference).

 

4.3 Certificate of Designation of Class C Preferred Stock (included as Exhibit 3.1 to the Form 8-K filed January 9, 1998, and incorporated herein by reference).

 

4.4 Certificate of Correction for Class C Preferred Stock (filed as Exhibit 3.2 to the Form 8-K filed January 9, 1998, and incorporated herein by reference).

 

4.5 Registration Rights Agreement between the Company and Dutchess Private Equities Fund, L.P., dated February 25, 2004 (included as Exhibit 10.10 to the Form SB-2 filed February 27, 2004, and incorporated herein by reference).

 

4.6 Rights Agreement between the Company and U.S. Stock Transfer Corporation dated October 28, 2005 (filed as Exhibit 4.1 to the Company's Form 8-A filed on November 2, 2005 and incorporated herein by reference).

 

4.7 Form of Class A Common Stock Purchase Warrant between the Company and Synthetica (America) Ltd., dated June 27, 2006 (filed herewith).

 

4.8 Form of Class B Common Stock Purchase Warrant between the Company and Synthetica (America) Ltd., dated June 27, 2006 (filed herewith).

 

4.9 Form of Class C Common Stock Purchase Warrant between the Company and Synthetica (America) Ltd., dated June 27, 2006 (filed herewith).

 

4.10 Form of Class D Common Stock Purchase Warrant between the Company and Synthetica (America) Ltd., dated June 27, 2006 (filed herewith).

 

10.1 Commercial Office Lease between the Company and L.A.T. Investment Corporation, dated August 16, 1999 (included as Exhibit 10.24 to the Form 10-KSB filed December 29, 1999, and incorporated herein by reference).

 

10.2 Form of Stock Option Agreement (included as Exhibit 10.5 to the Form 10-QSB filed August 14, 2002, and incorporated herein by reference).

 

10.3 Employment Agreement between the Company and John McLaughlin, dated November 2, 2002 (included as Exhibit 10.6 to the Form 10-QSB filed February 14, 2003, and incorporated herein by reference).

 

10.4 Amendment to Employment Agreement between the Company and John McLaughlin (included as Exhibit 10.5 to the Form 10-KSB filed December 29, 2004, and incorporated herein by reference).

 

10.5 Amendment to Commercial Office Lease between the Company and L.A.T. Investment Corporation (included as Exhibit 10.6 to the Form 10-KSB filed December 29, 2004, and incorporated herein by reference).

 

10.6 Investment Agreement between the Company and Dutchess Private Equities Fund, L.P., dated February 25, 2004 (included as Exhibit 10.9 to the Form SB-2 filed February 27, 2004, and incorporated herein by reference).

 

10.7 Placement Agent Agreement between the Company, Charleston Capital Securities, and Dutchess Private Equities Fund, L.P., dated February 25, 2004 (included as Exhibit 10.11 to the Form SB-2 filed February 27, 2004, and incorporated herein by reference).

 

10.8 Amended and Restated 2003 Stock Incentive Plan (included as Exhibit 10.1 to the Form S-8 filed April 13, 2005, and incorporated herein by reference).

 

31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1 Certification of Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

COMPUMED, INC.

Date August 14, 2006 By: /s/ John G. McLaughlin John G. McLaughlin President and Chief Executive Officer   Date August 14, 2006 By: /s/ Phuong Dang Phuong Dang Secretary, Controller and Principal Financial Officer

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