The following discussion and analysis should be read together with our condensed unaudited financial statements and the related notes appearing elsewhere in this quarterly report on Form 10-Q and with the audited financial statements and notes for the fiscal year ended December 31, 2019, and the information under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K filed with the SEC on March 9, 2020, or the Annual Report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See "Cautionary Note Regarding Forward-Looking Statements" for a discussion of the uncertainties, risks and assumptions associated with these statements. Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under "Risk Factors" in our Annual Report.





Overview

We are a company providing technology solutions to improve the clinical effectiveness and efficiency of healthcare providers. Our mission is to develop, manufacture and market innovative proprietary products and services that assist our customers in evaluating and treating chronic diseases. In 2011, we began commercializing our first patented and U.S. Food and Drug Administration, or FDA, cleared product, which measured arterial blood flow in the extremities to aid in the diagnosis of peripheral arterial disease, or PAD. In March 2015, we received FDA 510(k) clearance for the next generation version of our product, QuantaFlo®, which we began commercializing in August 2015. We believe our products and services position us to provide valuable information to our customer base, which in turn permits them to better guide patient care.

In the three months ended March 31, 2020, we had total revenues of $9,430,000 and net income of $2,673,000, compared to total revenues of $6,761,000 and net income of $1,854,000 in the same period in 2019.





Recent Developments

In the first quarter of 2020, new installations produced an overall net gain in fixed-fee license contracts. Requests for changes in billing arrangements in the quarter due to COVID-19 amounted to less than 1% of fixed-fee license contracts for QuantaFlo®.

Because we started to experience the effects of COVID-19 late in the first quarter, results in the first quarter are not indicative of any future quarter or the full fiscal year results. Test volumes have decreased due to "social distancing" and other executive orders mandating "shelter in place" or similar restrictions. This affects revenues from our variable-monthly fee arrangements, which are based on usage largely occurring during home visits.

In April 2020 compared to March 2020, fixed-fee monthly license revenues decreased by approximately 4% and variable fee software license revenues decreased by approximately 97%.

Although we do not provide formal guidance, we intend to manage our expenses and other costs in line with changes in revenues to conservatively preserve cash during these uncertain times. We believe customer interest in our QuantaFlo® product and related services will return to, or exceed, pre-COVID-19 activity at such time as "shelter-in place" or similar restrictions are lifted and non-emergency medical services resume.

Operating expenses are expected to decrease during the second quarter of 2020 as a result of cost-cutting measures that have included vendor fee reductions and decreased spending on consultants. To date, staffing, salaries and inventory have been maintained at usual levels, and travel expenses have decreased. Cash at April 30, 2020 increased compared to cash at March 31, 2020 primarily due to these cost-cutting measures, which have decreased our monthly operating expenses.

Until the effects of the COVID-19 pandemic on our business are more quantifiable, we do not plan to undertake any material changes to our business plan or operations.





Results of Operations

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019





Revenues

We had revenues of $9,430,000 for the three months ended March 31, 2020, an increase of $2,669,000, or 39%, compared to $6,761,000 in the same period in 2019. Our revenues are primarily from fees charged to customers for use of our vascular testing products and from sale of accessories used with these products. We recognized revenues of $9,160,000 from fees for our vascular testing products for the three months ended March 31, 2020, an increase of $2,645,000 compared to $6,515,000 in the same period of the prior year. The remainder was from other items, such as the sale of equipment, supplies or accessories sales, which were $270,000 in the three months ended March 31, 2020, as compared to $246,000 in the same period of the prior year.





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Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, usually billed as a fixed monthly fee or as a variable monthly fee dependent on usage. The primary reason for the increase in revenues was growth in the number of installed units from both new customers and established customers, which we believe is the result of our sales and marketing efforts.





Operating expenses

We had total operating expenses of 5,978,000 for the three months ended March 31, 2020, an increase of $1,071,000 or 22%, compared to $4,907,000 in the same period in the prior year. The primary reason for this change was overall growth in our business, increased compensation of the sales team and increased headcount of field sales and technical support personnel to service the expanding number of customers. As a percentage of revenues, operating expenses decreased to 63% as compared to 73%. The changes in the various components of our operating expenses are described below.





 Cost of revenues

We had cost of revenues of $850,000 for the three months ended March 31, 2020, a decrease of $46,000, or 5%, compared to $896,000 in the same period of the prior year. The primary reason for this change was lower depreciation per unit per month as a greater percentage of installations were software and sensor only rather than laptop, software and sensor, as well as lower residual value for retired units. As a percentage of revenues, cost of revenues decreased to 9%, as compared to 13%, primarily due to revenues growing at a faster pace than cost of revenues.

Engineering and product development expense

We had engineering and product development expense of $842,000 for the three months ended March 31, 2020, an increase of $273,000, or 48%, compared to $569,000 in the same period of the prior year. The increase was primarily due to timing of consultant costs, personnel and other costs associated with our product development and customization efforts. As a percentage of revenues, engineering and product development expense decreased to 9%, as compared to 8%.





Sales and marketing expense

We had sales and marketing expense of $2,695,000 for the three months ended March 31, 2020, an increase of $625,000, or 30%, compared to $2,070,000 in the same period of the prior year. The increase was primarily due to higher sales compensation and personnel expense and the continued expansion of existing customer orders, marketing activities and increased headcount and associated expense. As a percentage of revenues, sales and marketing expense decreased to 29%, as compared to 31%.

General and administrative expense

We had general and administrative expense of $1,591,000 for the three months ended March 31, 2020, an increase of $219,000, or 16%, compared to $1,372,000 in the same period of the prior year. The increase was primarily due to the growth in our business, which led to increased expenses to support a growing company, including higher infrastructure costs, insurance and other professional fees, as well as higher compensation and personnel expense. As a percentage of revenues, general and administrative expense decreased to 17%, as compared to 20%.





Other expense

We had other expense of $2,000 for the three months ended March 31, 2020, compared to no other expense in the same period of the prior year. The increase was primarily due to credit card fees, partially offset by interest income.





Pre-tax net income

For the foregoing reasons, we had pre-tax net income of $3,450,000, or $0.53 per basic share and $0.43 per diluted share, for the three months ended March 31, 2020, an increase of $1,596,000, or 86%, compared to a pre-tax net income of $1,854,000, or $0.29 per basic share and $0.23 per diluted share, for the same period of the prior year.





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Income tax expense

We had income tax expense of $777,000 for the three months ended March 31, 2020, compared to no income tax expense in the same period of the prior year. The increase was primarily due to amortization of our deferred tax asset.





Net income

For the foregoing reasons, we had net income of $2,673,000, or $0.41 per basic share and $0.33 per diluted share, for the three months ended March 31, 2020, an increase of $819,000, or 44%, compared to a net income of $1,854,000, or $0.29 per basic share and $0.23 per diluted share, for the same period of the prior year.

Liquidity and Capital Resources

We had cash of $11,214,000 at March 31, 2020 compared to $7,741,000 at December 31, 2019, and total current liabilities of $3,820,000 at March 31, 2020 compared to $5,207,000 at December 31, 2019. As of March 31, 2020, we had working capital of approximately $9,663,000.

Our cash is held in a variety of non-interest bearing bank accounts and interest-bearing instruments subject to investment guidelines allowing for holdings in U.S. government and agency securities, corporate securities, taxable municipal bonds, commercial paper and money market accounts. In addition, we may also choose to invest some of our cash resources in other entities that may have complementary technologies or product offerings





Operating activities

We generated $3,742,000 of net cash from operating activities for the three months ended March 31, 2020 compared to $1,703,000 of net cash from operating activities for the same period of the prior year. The improvement was primarily due to changes in net income, as well as both non-cash adjustments and operating assets and liabilities, which occurred due to growth in our business. Non-cash adjustments to reconcile net income to net cash from operating activities were $1,044,000. These non-cash adjustments were primarily due to deferred tax expense of $721,000, depreciation of assets for lease of $128,000, stock-based compensation expense of $67,000, loss on disposal of assets for lease of $66,000, fixed assets depreciation and amortization of $31,000 and allowance for bad debt expense of $31,000. Changes in operating assets and liabilities provided $25,000 of net cash. These changes in operating assets and liabilities included cash provided by trade accounts receivable of $1,875,000, accounts payable of $39,000 and deferred revenue of $34,000, partially offset by cash used by accrued expenses of $1,466,000 and prepaid expenses of $457,000.





Investing activities

We used $272,000 of net cash in investing activities for the three months ended March 31, 2020, which reflects purchases of assets for lease of $181,000 and fixed asset purchases of $91,000 to support our growing business.

We used $456,000 of net cash in investing activities for the three months ended March 31, 2019, which reflects purchases of assets for lease of $425,000 and fixed asset purchases of $31,000 to support our growing business.





Financing activities

We generated $3,000 in net cash from financing activities during the three months ended March 31, 2020, primarily due to proceeds from exercise of stock options.

We generated $13,000 in net cash from financing activities during the three months ended March 31, 2019, primarily due to proceeds from exercise of stock options.

Off-Balance Sheet Arrangements

As of each of March 31, 2020 and December 31, 2019, we had no off-balance sheet arrangements.





Commitments and Contingencies

As of each of March 31, 2020 and December 31, 2019, other than employment/consulting agreements with key executive officers and our facilities lease obligation, we had no material commitments other than the liabilities reflected in our financial statements.

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