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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-K

[X]  ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE ACT OF
     1934 For the fiscal year ended May 31, 2006

[ ]  TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
     ACT OF 1934 For the transition period from _____ to _____

                           Commission File No. 0-18105

                       ----------------------------------
                                VASOMEDICAL, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                            11-2871434
(State or other jurisdiction of                              (IRS Employer
 incorporation or organization)                            Identification No.)

 180 Linden Avenue, Westbury, New York                          11590
(Address of Principal Executive Offices)                      (Zip Code)

       Registrant's telephone number, including area code: (516) 997-4600

           Securities registered under Section 12(b) of the Act: None

              Securities registered under Section 12(g) of the Act:
                          Common Stock, $.001 par value
                                (Title of Class)

Indicate by check mark if the  registrant is a well-known  seasoned  issuer,  as
defined in Rule 405 of the Securities Act. Yes [ ] No [ X ]

Indicate  by  check  mark if the  registrant  is not  required  to file  reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [ X ]

Indicate  by a check  mark  whether  the  registrant  (1) has filed all  reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer, or a  non-accelerated  filer.  Large  Accelerated  Filer [ ]
Accelerated Filer [ ] Non-Accelerated Filer [ X ]

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]

The aggregate  market value of the voting and  non-voting  common equity held by
non-affiliates of the registrant (based on the closing sale price of $0.42 as of
November 30, 2005, was approximately $23,831,000. Shares of common stock held by
each  officer  and  director  and by  each  person  who  owns  5% or more of the
outstanding  common stock have been  excluded in that such persons may be deemed
to be affiliates.  The  determination of affiliates  status is not necessarily a
conclusive determination for other purposes.

At August 16, 2006,  the number of shares  outstanding  of the  issuer's  common
stock was 65,198,592.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Part III - (Items  10,  11, 12, 13 and 14)  Registrant's  definitive  proxy
statement to be filed pursuant to Regulation 14A of the Securities  Exchange Act
of 1934.
<PAGE>
















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<PAGE>
                               INDEX TO FORM 10-K
<TABLE>
<CAPTION>
                                                                                                              Page
                                                                                                              ----
                                     PART I

<S>           <C>                                                                                              <C>
Item 1.       Business..........................................................................................1
Item 1A.      Risk Factors.....................................................................................16
Item 2.       Properties.......................................................................................20
Item 3.       Legal Proceedings................................................................................21
Item 4.       Submission of Matters to a Vote of Security Holders..............................................21

                                     PART II

Item 5.       Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of
              Equity Securities................................................................................22
Item 6.       Selected Financial Data..........................................................................23
Item 7.       Management's Discussion and Analysis of Financial Condition and Results of Operations............25
Item 7A.      Quantitative and Qualitative Disclosures about Market Risk.......................................37
Item 8.       Financial Statements and Supplementary Data......................................................37
Item 9.       Changes in and Disagreements with Accountants and Accounting and Financial Disclosure............37
Item 9A.      Controls and Procedures..........................................................................38

                                    PART III

Item 10.      Directors and Executive Officers of the Registrant...............................................39
Item 11.      Executive Compensation...........................................................................39
Item 12.      Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ..39
Item 13.      Certain Relationships and Related Transactions...................................................39
Item 14.      Principal Accountant Fees and Services...........................................................39

                                     PART IV

Item 15.      Exhibits and Financial Statement Schedules.......................................................40

Signatures    .................................................................................................42

                                    EXHIBITS

Exhibit 23    Consents of Independent Registered Public Accounting Firms......................................E-1

Exhibit 31    Certifications Pursuant to Securities Exchange Act Rule 13A-14(A)/15D-14(A).....................E-2

Exhibit 32    Certification of Periodic Report................................................................E-4
</TABLE>

                                      - i -
<PAGE>
                                     PART I


ITEM 1 - BUSINESS

     Except for historical  information  contained herein, the matters discussed
are forward looking statements that involve risks and  uncertainties.  When used
herein,  words  such  as  "anticipates",   "believes",  "estimates",  "expects",
"feels",  "plans",  "projects"  and "intends" and similar  expressions,  as they
relate to us, identify  forward-looking  statements In addition,  any statements
that refer to our plans, expectations,  strategies or other characterizations of
future   events  or   circumstances   are   forward-looking   statements.   Such
forward-looking statements are based on our beliefs, as well as assumptions made
by and information currently available to us. Among the factors that could cause
actual  results  to  differ  materially  are the  following:  the  effect of the
dramatic  changes  taking  place in the  healthcare  environment;  the impact of
competitive  procedures  and  products  and  their  pricing;  medical  insurance
reimbursement   policies;    unexpected   manufacturing   problems;   unforeseen
difficulties  and delays in the  conduct of  clinical  trials and other  product
development  programs;  the actions of regulatory  authorities  and  third-party
payers in the United States and overseas;  uncertainties about the acceptance of
a novel  therapeutic  modality by the medical  community;  and the risk  factors
reported  from time to time in our SEC reports.  We undertake no  obligation  to
update forward-looking statements as a result of future events or developments.

General Overview

     Vasomedical,  Inc. was  incorporated  in Delaware in July 1987.  Unless the
context requires  otherwise,  all references to "we",  "our",  "us",  "Company",
"registrant",  "Vasomedical"  or "management"  refer to Vasomedical Inc. and its
subsidiaries.   Since  1995,  we  have  been  primarily  engaged  in  designing,
manufacturing,    marketing   and   supporting    EECP(R)   enhanced    external
counterpulsation  systems based on our unique proprietary  technology  currently
indicated  for use in cases of stable or unstable  angina  (i.e.,  chest  pain),
congestive heart failure (CHF), acute myocardial infarction (i.e., heart attack,
(MI))  and  cardiogenic  shock.  The  EECP  therapy  system  is a  non-invasive,
outpatient therapy for the treatment of diseases of the  cardiovascular  system.
The therapy serves to increase  circulation in areas of the heart with less than
adequate  blood  supply  and helps to restore  systemic  vascular  function.  We
provide hospitals,  clinics and physician private practices with EECP equipment,
treatment  guidance,  and a staff  training and  equipment  maintenance  program
designed to provide optimal patient outcomes. EECP is a registered trademark for
Vasomedical's enhanced external counterpulsation systems.

     We have  incurred  declines in revenue  and  significant  operating  losses
during the last three  fiscal  years and our ability to continue  operating as a
going concern is dependent upon achieving  profitability  or through  additional
debt or equity  financing.  Achieving  profitability is largely dependent on our
ability to reduce  operating  costs  sufficiently as well as halting the current
trend of declining revenue.  Our ability to maintain our current base of revenue
is largely  dependent upon  restructuring our sales and marketing efforts in the
angina market where reimbursement is currently available and operating in a more
efficient  manner.  If we are not able to reverse the trend of declining revenue
and  sufficiently  reduce  operating costs to generate an adequate cash flow, or
raise additional capital, we will not be able to continue as a going concern.

     In order to reduce  the cash burn and  bring our cost  structure  more into
alignment with current revenue, we initiated a company  restructuring in January
2006, to reduce personnel and spending on marketing and development projects. We
anticipate that the restructuring  will reduce  manufacturing and operating cost
by approximately $3 million per year compared to prior levels.  In addition,  in
April 2006,  the board of  directors  elected to defer  meeting fees and certain
senior executives  elected to defer  approximately $0.4 million in annual salary
compensation.  We believe  that these  steps to conserve  cash will  provide the
Company  with the  opportunity  to rebuild  sales to a  profitable  level and/or
explore strategic opportunities.

     Based on the continuation of current revenue levels and the  implementation
of our restructuring  plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.

     In the event that additional capital is required, we may seek to raise such
capital  through public or private equity or debt  financings or other means. We
may not be able to obtain additional  financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further  scale back our  operations,  research,  marketing  or sales  efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish  rights to technologies or products.  Future
capital funding, if available,  may result in dilution to current  shareholders,
and new investors  could have rights superior to existing  stockholders.

                                       1
<PAGE>

Market Overview

     Cardiovascular disease (CVD) is the leading cause of death in the world and
is among the top three diseases in terms of healthcare  spending in nearly every
country.  CVD claimed  approximately  2.4 million  lives in the United States in
2003 and was  responsible  for 1 of every 2.7 deaths,  according to The American
Heart Association (AHA) Heart and Stroke  Statistical 2006 Update (2006 Update).
Approximately  71.3 million  Americans  suffer from some form of  cardiovascular
disease. Among these, 12.0 million have coronary heart disease (CHD).

     We have Food and Drug  Administration  (FDA)  clearance  to market our EECP
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock, however our current
marketing  efforts are limited to the treatment of stable angina and  congestive
heart  failure  indications.  Within  the  stable  angina  and CHF  indications,
Medicare and other  third-party  payers  currently  reimburse  for stable angina
patients with moderate to severe  symptoms who do not adequately  respond or are
not amenable to medications and not candidates for invasive procedures. Ischemic
heart failure patients are also reimbursed under the same criteria provided they
have  documented  history of coronary  artery  disease  (CAD) and they are being
treated for angina or angina  equivalent  symptoms  as outlined in the  American
College of  Cardiology/American  Heart Association 2002 Guideline Update for the
Management of Patients With Chronic Stable Angina.

     We have actively engaged in research to establish the potential benefits of
EECP  therapy  in the  management  of CHF  and  sponsored  a  pivotal  study  to
demonstrate  the efficacy of EECP therapy in the most  prevalent  types of heart
failure patients.  This study, known as PEECH (Prospective Evaluation of EECP in
Congestive Heart Failure), provided additional clinical data in order to support
the use of EECP therapy in the treatment of CHF. The preliminary  results of the
trial were presented at the American College of Cardiology  scientific  sessions
in March  2005,  and we expect  the  results of the PEECH  clinical  trial to be
published in a peer-reviewed  journal.  In June 2005 we submitted an application
to the Centers for Medicare and Medicaid Services (CMS) for expanded coverage of
EECP therapy to include CHF as a primary indication,  plus expanded coverage for
patients with milder  angina.  In March 2006, CMS issued a final decision not to
expand  coverage  and  keep  the  existing  coverage  as  stated  prior  to  our
application.  CMS has  advised us that in order for them to fully  consider  the
results of the PEECH  clinical  study it must be  published  in a  peer-reviewed
medical journal,  therefore we intend to submit a revised  application to CMS to
again consider  expanding  coverage for heart failure patients once the study is
published.

     However,  there can be no assurance  that our revised  application  will be
accepted by CMS for review or that reimbursement  coverage will be expanded even
if the  application  is  accepted  for  review.  If we are  unable  to obtain an
adequate national  Medicare coverage policy for treatment  procedures using EECP
therapy on patients  with CHF,  it would  adversely  affect our future  business
prospects.

Angina
         Angina pectoris is the medical term for a recurring pain or discomfort
in the chest due to coronary heart disease. Angina is a symptom of a condition
called myocardial ischemia, which occurs when the heart muscle or myocardium
doesn't receive as much blood, hence as much oxygen, as it needs. This usually
happens because one or more of the heart's arteries, the blood vessels that
supply blood to the heart muscle, is narrow or blocked. Insufficient blood
supply to meet the need of the organ to function is called ischemia.

     The  cardinal  symptom of stable CAD is  anginal  chest pain or  equivalent
symptoms,   such  as  exertional  dyspnea.  Angina  is  uncomfortable  pressure,
fullness,  squeezing or pain usually  occurring in the center of the chest under
the breastbone. The discomfort also may be felt in the neck, jaw, shoulder, back
or arm.  Often the patient  suffers not only from the  discomfort of the symptom
itself  but  also  from  the  accompanying  limitations  on  activities  and the
associated  anxiety that the symptoms may produce.  Uncertainty  about prognosis
may be an  additional  source of anxiety.  For some  patients,  the  predominant
symptoms  may be  palpitations  or  syncope  that is  caused by  arrhythmias  or
fatigue,  edema, or orthopnea caused by heart failure.  Episodes of angina occur
when the heart's need for oxygen  increases beyond the oxygen available from the
blood nourishing the heart. Physical exertion is the most common though not only
trigger for angina. For example,  running to catch a bus could trigger an attack
of angina while walking might not. Angina may happen during exercise, periods of
emotional  stress,  exposure  to  extreme  cold or heat,  heavy  meals,  alcohol
consumption  or cigarette  smoking.  Some people,  such as those with a coronary
artery spasm, may have angina when they are resting.

     There are  approximately  6.4 million angina  patients in the United States
and our EECP therapy  currently  competes with other  technologies in the market
for  approximately  130,000 new angina  patients  annually who do not adequately
respond to or are not  amenable  to medical  and  surgical  therapy and have the
potential to meet the guidelines for reimbursement of EECP therapy.  Most angina
patients  are treated  with  medications,  including  beta  blockers to slow and

                                       2
<PAGE>

protect the heart and vasodilators, which are often prescribed to increase blood
flow to the  coronary  arteries.  When drugs fail or  inadequately  correct  the
problem the patients are  considered  unresponsive  to medical  therapy.  If the
patient is  readily  amenable,  invasive  revascularization  procedures  such as
angioplasty  and coronary  stent  placement,  as well as coronary  artery bypass
grafting (CABG) are often employed.

     In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that  administers  the Medicare  program for more than 39 million
beneficiaries,  issued  a  national  coverage  policy  for the  use of  external
counterpulsation  therapy in the  treatment  of angina.  Medicare  reimbursement
guidelines  have a significant  impact in determining  the available  market for
EECP therapy. We believe that over 65% of the patients that receive EECP therapy
are  Medicare  patients  and  many of the  third-party  payers  follow  Medicare
guidelines,  which limits  reimbursement for EECP therapy to patients who do not
adequately respond to or are not amenable to medical therapy and are not readily
amenable to surgical therapy.  As a result, an important element of our strategy
is to grow the market for EECP  therapy by expanding  reimbursement  coverage to
include a broader  range of angina  patients  than the current  coverage  policy
provides and enabling  EECP  therapy to compete  more with other  therapies  for
ischemic heart disease.  Please see the heading  "Reimbursement"  in the "Item-1
Business"  section  of  this  Form  10-K  for  a  more  detailed  discussion  of
reimbursement issues.

Congestive Heart Failure

     CHF is a condition  in which the heart loses its full  pumping  capacity to
supply the metabolic needs of all other organs. The condition affects both sexes
and is most common in people over age 50. Symptoms include angina,  shortness of
breath,  weakness,  fatigue,  swelling of the abdomen, legs and ankles, rapid or
irregular heartbeat and low blood pressure. Causes range from chronic high blood
pressure,  heart-valve disease, heart attack, coronary artery disease, heartbeat
irregularities,  severe lung  disease  such as  emphysema,  congenital  disease,
cardiomyopathy, hyperthyroidism, severe anemia and others.

     CHF is treated with medication and,  sometimes,  surgery on heart valves or
the coronary  arteries and, in certain  severe cases,  heart  transplants.  Left
ventricular assist devices (LVADs) and the use of cardiac  resynchronization and
implantable  defibrillators  are useful in selected patients with heart failure.
Still, no consensus therapy currently exists for CHF and patients must currently
suffer their symptoms chronically and have a reduced life expectancy.

     According to the 2006 Update, in 2003 approximately 2.4 million men and 2.6
million women in the US had CHF and about 550,000 new cases of the disease occur
each year.  Deaths caused by the disease  increased 20.5% from 1993 to 2003. The
prevalence of the disease is growing as a result of the aging of the  population
and the  improved  survival  rate of people  after  heart  attacks.  Because the
condition  frequently  entails  visits  to the  emergency  room  and  in-patient
treatment centers, two-thirds of all hospitalizations for people over age 65 are
due to CHF. The economic burden of congestive  heart failure is enormous with an
estimated  2005 cost to the health  care  system in the  United  States of $29.6
billion.  Congestive  heart failure offers a good strategic fit with our current
angina  business and offers an expanded  market  opportunity  for EECP  therapy.
Unmet clinical needs in CHF are greater than those for angina,  as there are few
consensus  therapies,  invasive or otherwise,  beyond medical management for the
condition.  It is noteworthy  that data  collected from the  International  EECP
Patient  Registry(TM)  (IEPR) at the University of Pittsburgh Graduate School of
Public Health shows that approximately one-third of angina patients treated also
have a history of CHF and have demonstrated positive outcomes from EECP therapy.

     The  PEECH  clinical  trial  provided   additional   clinical  evidence  to
demonstrate the potential benefits of EECP therapy in the management of CHF, and
we included a summary of the results of the PEECH  trial in our  application  to
CMS to expand  reimbursement  coverage  to  include  CHF.  The  application  was
accepted by CMS on June 20, 2005, and CMS announced  their final decision not to
expand coverage on March 20, 2006.  Since the PEECH trial had not been published
in a peer-reviewed  journal prior to CMS issuing a final decision,  we intend to
resubmit a new  application  to CMS  requesting  additional  coverage to include
heart failure  patients once the PEECH manuscript is published.  However,  there
can be no  assurance  that the  results  of the  PEECH  trial or other  clinical
evidence  will be  sufficient  to support  expansion  of the  Medicare  national
coverage policy for EECP treatment.

The EECP Therapy Systems

     The  EECP  therapy  systems  are  advanced   treatment   systems  utilizing
fundamental  hemodynamic  principles to augment  coronary  blood flow and at the
same time reduce the workload of the heart while improving the overall  vascular
function.  The  treatment  is  completely  noninvasive  and is  administered  to
patients on an outpatient basis,  usually in daily one-hour sessions,  five days
per week over seven weeks for a total of 35  treatments.  The  procedure is well
tolerated  and most  patients  begin to  experience  relief of chest pain due to
their coronary  artery disease after 15 to 20 hours of therapy.  As demonstrated
in our clinical  studies,  positive  effects have been shown in most patients to
continue for years following a full course of therapy.

                                       3
<PAGE>
     During EECP therapy,  the patient lies on a contoured treatment table while
three sets of inflatable  pressure  cuffs,  resembling  oversized blood pressure
cuffs, are wrapped around the calves, and the lower and upper thighs,  including
the buttocks.  The system is  synchronized to the individual  patient's  cardiac
cycle triggering the system to inflate the cuffs rapidly and sequentially -- via
computer-interpreted  ECG  signals --  starting  from the calves and  proceeding
upward to the buttocks during the relaxation phase of each heartbeat (diastole).
This has the effect of creating a strong retrograde counterpulse in the arterial
system, forcing freshly oxygenated blood towards the heart and coronary arteries
at a time when  resistance to coronary  blood flow is at its lowest  level.  The
counter pulse also simultaneously increases the volume of venous blood return to
the heart when the heart is filling up for  ejection in the  contracting  phase.
Just  prior to the  next  heartbeat  when the  heart  begins  to eject  blood by
contracting  (systole),  all three cuffs simultaneously  deflate,  significantly
reducing the workload of the heart.  This is achieved  because the vascular beds
in the lower  extremities  are  relatively  empty  when the cuffs are  deflated,
significantly lowering the resistance, and provide vascular space to receive the
blood  ejected  by the heart,  reducing  the amount of work the heart must do to
pump oxygenated blood to the rest of the body. The inflation/deflation  activity
is  monitored   constantly  and  coordinated  by  a  computerized  console  that
interprets  electrocardiogram  signals from the patient's heart,  monitors heart
rhythm and rate  information,  and  actuates  the  inflation  and  deflation  in
synchronization  with the  cardiac  cycles.  The end  result of this  sequential
"squeezing"  of the  legs  is to  create  a  pressure  wave  that  significantly
increases peak diastolic pressure benefiting circulation to the heart muscle and
other organs, increases venous return so that the heart has more blood volume to
eject out,  and  increases  cardiac  output.  The release of  external  pressure
produces  reduction of systolic  pressure,  thereby reducing the workload of the
heart.  This  reduction of vascular  resistance  insures that the heart does not
have to work as hard to pump  large  amounts of blood  through  the body to help
supply its metabolic needs.

     While the  precise  scientific  means by which EECP  therapy  achieves  its
long-term beneficial effects are only partially explained,  there is evidence to
suggest that the EECP therapy triggers a neurohormonal response that induces the
production of growth and vasodilatation factors that promotes recruitment of new
arteries and dilates  existing  blood vessels.  The  recruitment of new arteries
known as  "collateral  blood  vessels"  bypass  blocked or narrowed  vessels and
increase  blood flow to ischemic areas of the heart muscle that are receiving an
inadequate  supply of  blood.  There is also  evidence  to  support a  mechanism
related to improved  function of the endothelium  (the inner lining of the blood
vessels),  which  regulates  the luminal  size of the  arteries and controls the
dilation of the  arteries  to insure  adequate  blood flow to all  organs,  thus
reducing  constriction  of blood  vessels  that supply  oxygenated  blood to the
body's organs and tissues and as a result the required workload of the heart.

Clinical Studies

Early History

     Early   experiments   with   counterpulsation   at  Harvard  in  the  1950s
demonstrated that this technique markedly reduces the workload,  and thus oxygen
consumption, of the left ventricle. This basic effect has been demonstrated over
the past forty years in both animal  experiments  and in patients.  The clinical
benefits of external  counterpulsation  were not consistently  achieved in early
studies because the equipment used then lacked some of the features found in the
current EECP systems, such as the computerized  electrocardiographic  signal for
triggering, and the use of pneumatic versus hydraulic actuating media that makes
sequential cuff inflation  possible.  As the technology  improved,  however,  it
became  apparent  that both internal  (i.e.  intra-aortic  balloon  pumping) and
external  forms of  counterpulsation  were  capable  of  improving  survival  in
patients with cardiogenic shock following myocardial  infarction.  Later, in the
1980s, Dr. Zheng and colleagues in China reported on their extensive  experience
in treating angina using the newly developed "enhanced"  sequentially  inflating
EECP device that  incorporated  three sets of cuffs  including the buttocks cuff
instead of a single cuff used in the previous system. The Chinese  investigators
were able to show  that a  36-hour  course  of  treatment  with the EECP  system
reduced the  frequency  and  severity of anginal  symptoms  during  normal daily
functions  and also  during  exercise,  and  also  that  the  improvements  were
sustained for years after therapy.

     These results  prompted a group of investigators at the State University of
New York at Stony  Brook  (Stony  Brook) to  undertake  a number  of open  label
studies  with the EECP system  between  1989 and 1996 to  reproduce  the Chinese
results,  using both subjective and objective endpoints.  These studies,  though
open  label and  non-randomized,  showed  significant  improvement  in  exercise
tolerance  by  patients  as  evidenced  by exercise  treadmill  stress  testing,
improvement in the perfusion of ischemic regions of the heart muscle by thallium
radionuclide  imaging  stress  testing,  and partial or complete  resolution  of
coronary perfusion  defects.  All of these results have been reported in medical
literature  and support the  assertion  that EECP  therapy is an  effective  and
durable treatment for patients suffering from chronic angina pectoris.

                                       4
<PAGE>
The MUST-EECP Study

     In 1995, we began a randomized,  controlled and double-blinded  multicenter
clinical study (MUST-EECP) at seven leading  university  hospitals in the United
States to confirm the patient benefits observed in the open studies conducted at
Stony Brook and to provide  definitive  scientific  evidence  of EECP  therapy's
effectiveness. MUST-EECP was completed in July 1997 and the results presented at
the annual  meetings of the American Heart  Association in November 1997 and the
American  College of  Cardiology  in March 1998.  The results of MUST-EECP  were
published in the Journal of the American  College of Cardiology  (JACC), a major
peer-review medical journal, in June 1999.

     This  139  patient  study,   which  included  a  sham-EECP  control  group,
demonstrated  that patients  treated with EECP therapy were able to increase the
amount of time on exercise  testing before they showed signs of cardiac ischemia
(i.e.  ST-segment  depression  on their  electrocardiogram)  and  experienced  a
reduction in the frequency of their angina attacks  compared to patients who did
not  receive  EECP  therapy.  In  1999,  physician   collaborators  completed  a
quality-of-life study with the EECP system in a subset of the same patients that
participated in MUST-EECP. Two highly regarded standardized means of measurement
were used to gauge changes in patients'  outlook and ability to  participate  in
normal daily  living  during the  treatment  phase and for up to 12 months after
treatment.  Results of this study, which have been presented at major scientific
meetings and  published in the January 2002 Journal of  Investigative  Medicine,
show that after  one-year  of  follow-up  the group of patients  receiving  EECP
therapy enjoyed significantly improved aspects of health-related quality of life
compared to those who received a sham treatment.

The PEECH Study

     As part of our program to expand the therapy's  indications  for use beyond
the treatment of angina,  we applied for and received FDA approval in April 1998
to  study,  under  an  Investigational  Device  Exemption  (IDE)  protocol,  the
application  of EECP therapy in the  treatment of CHF. A 32 patient  feasibility
study  was  conducted  simultaneously  at  the  University  of  Pittsburgh,  the
University  of  California  San  Francisco  and  the  Grant/Riverside  Methodist
Hospitals in  Columbus,  Ohio.  The results of this study were  presented at the
49th Scientific Sessions of the American College of Cardiology in March 2000 and
the Heart Failure Society of America's Annual Meeting in September 2000 and were
published in the July/August 2002 issue of Congestive Heart Failure.  This study
indicated that EECP therapy could improve exercise capacity, increase functional
capacity was beneficial to left  ventricular  function in patients with New York
Heart Association  (NYHA) Class II and III (i.e. mild to moderate) heart failure
and a reduced left ventricular ejection fraction (i.e. LVEF = 35% or less).

         In summer 2000, an IDE supplement to proceed with a pivotal study to
demonstrate the efficacy of EECP therapy in the most prevalent types of heart
failure patients was approved. This study, known as PEECH (Prospective
Evaluation of EECP in Congestive Heart Failure), began patient enrollment in
March 2001. The PEECH clinical trial involved nearly thirty centers including:
the Cleveland Clinic, Mayo Clinic, Scripps Clinic, Thomas Jefferson University
Hospital, the University of North Carolina at Chapel Hill, the Minnesota Heart
Failure Consortium, Advocate Christ Hospital, Hull Infirmary (UK), the
University of California at San Diego Medical Center, the University of
Pittsburgh Medical Center, the Lindner Clinical Trial Center and the
Cardiovascular Research Institute. Vasomedical obtained 510(k) clearance for CHF
from FDA in June 2002, obviating the need to continue this trial for FDA
regulatory reasons. However, we decided to complete the clinical trial in order
to use the anticipated clinical outcomes to help establish the clinical
validation of EECP therapy as a treatment for CHF and to provide additional
scientific support for Medicare, Medicaid and other third-party payers to expand
reimbursement coverage of EECP therapy to include the CHF indication.

     The  protocol  for the study  required  that  patients  have NYHA II or III
symptoms,  have an LVEF of 35% or less, be able to undergo  exercise testing and
complete patient examinations 1-week,  3-months and 6-months following treatment
that evaluated  changes from baseline in exercise  capacity,  symptom status and
quality of life.  Patients  were  randomized  to receive  either  optimal  (i.e.
guideline-recommended) medical therapy (OPT) or EECP therapy in addition to OPT.
Enrollment of patients into the PEECH trial was completed in February 2004, with
187 patients, and the six-month follow-up examinations were completed by the end
of December 2004.

     On March 8,  2005,  the  preliminary  PEECH  clinical  trial  results  were
presented  by Arthur M.  Feldman,  MD, PhD,  Principal  Investigator,  in a Late
Breaking  Clinical Trials session of the American College of Cardiology  ("ACC")
Annual Scientific  Session.  Simultaneously,  the Company announced the positive
results of the trial to the public in a Press Release.

     In designing the PEECH trial,  success was  demonstrated  if the difference
between EECP therapy  combined with optimal medical therapy  compared to optimal
medical  therapy alone achieved a p-value less than 0.025 in at least one of two
pre-defined co-primary endpoints:

                                       5
<PAGE>
     1.   percentage  of  subjects  with  greater  than or equal  to 60  seconds
          improvement in exercise duration from baseline to six months, or

     2.   percentage of subjects with at least 1.25  mL/kg/min  increase in peak
          oxygen consumption from baseline to six months.

     Additional secondary endpoints were actual changes in exercise duration and
peak  oxygen  consumption,  changes  in  New  York  Heart  Association  ("NYHA")
functional  classification,  changes in quality of life, adverse experiences and
pre-defined clinical outcomes.

     The study was a positive  clinical trial on the basis that a  significantly
greater  proportion  of patients  who  underwent  EECP  therapy  improved  their
exercise  duration  by 60  seconds or more six months  following  completion  of
therapy compared to those who received OPT alone (35.4% vs. 25.3%, p=0.016). The
proportion of patients  achieving a 1.25  mL/kg/min  improvement  in peak oxygen
consumption  was not  significantly  different  between  the two  groups  at six
months.

     Consistent with the results on the primary  endpoint of exercise  duration,
statistically  significant differences favoring the EECP-treated group were seen
in changes in average  exercise  duration,  symptom  status and  quality of life
during follow-up.  Average peak oxygen  consumption  showed a trend favoring the
EECP group at 1 week, but there were no differences detected at later follow-up.
Results in patients  with heart  failure of ischemic  etiology  were noted to be
clearly superior to those patients of idiopathic  etiology though the benefit in
these later patients could not be ruled out statistically.  Lastly, EECP therapy
was deemed safe and well tolerated in this group of patients, as patients in the
EECP-treated  group did not suffer more adverse events than those in the control
group.

     Moreover, results of a predefined subgroup analysis showed that patients 65
years  of age or  older  not  only had a  significantly  greater  response  rate
(co-primary   endpoint)  and  average  change  in  exercise   duration  favoring
EECP-treated  patients,  but the response rate (co-primary endpoint) and average
change  in  peak  oxygen  consumption  were  also  significantly  better  out to
completion of the study at six months follow-up.

     The  results  of the  PEECH  trial  indicate  that  EECP  therapy  provides
beneficial  adjunctive therapy in patients with NYHA Class II-III systolic heart
failure receiving optimal pharmacological therapy,  especially in those 65 years
of age or  older.  There  can be no  assurance  that the  results  of the  PEECH
clinical  trial  will be  sufficient  to expand  reimbursement  coverage  or the
adoption by the medical  community of EECP  therapy for use in the  treatment of
congestive heart failure.

The International EECP Patient Registry (IEPR(TM))

     The  International  EECP Patient  Registry at the  University of Pittsburgh
Graduate  School of Public Health was  established  in January 1998 to track the
outcomes of angina  patients  who have  undergone  EECP  therapy.  More than one
hundred centers have  participated in the registry and data from more than 5,000
patients  from an initial  cohort  enrolled  between 1998 and 2001 (IEPR-1) have
been tabulated and reported in several peer-reviewed publications.

     The American  Journal of Cardiology  published a report in February of 2004
on the two-year  outcomes  after EECP therapy  observed in 1,097  patients  with
two-year follow-up enrolled in IEPR-1. The authors noted that 73% of patients in
this cohort had a decrease in their angina  symptom  status upon  completion  of
EECP  therapy and that the average  number of angina  episodes for the group was
reduced from 10.6 to 2.8 per week.  They  characterized  this  improvement  as a
"significant  and  dramatic  reduction  in CCSC"  and  stated  that the  adverse
clinical  event  rate  was  low.  (CCSC,  or  Canadian   Cardiovascular  Society
Classification,  is a rating scale used by physicians to assess the  limitations
imposed on patients'  lives by angina.)  Patients also reported  improvement  in
health status, quality of life and satisfaction with life.

     At two-years  follow-up,  74.9% of patients  reported  their angina symptom
status  (CCSC  class) was  improved  compared  to before EECP  therapy,  and the
accompanying  improvements in angina frequency and quality of life measures were
largely  sustained as well. Nine per cent of patients had died over the two-year
follow-up  and 15% had  undergone a  revascularization  procedure  (angioplasty,
stenting or coronary bypass surgery).

     The authors  summarize the results by stating "Most patients  experienced a
significant  reduction in angina and  improvement  in quality of life after EECP
therapy, and this reduction was sustained in most patients at 2-year follow-up."

     In a separate report that appeared in The American Journal of Cardiology in
2005,  physician  investigators  participating  in the IEPR(TM)  reported on the
results  of EECP  therapy in  patients  with  angina  who also had  severe  left
ventricular  dysfunction  (LVD,  a  reduced  pumping  capacity  of  the  heart).
Previously  it was thought  that such  patients,  and those with a diagnosis  of
heart  failure,  would be put at risk if treated with EECP  therapy,  due to the
increase in venous return to the heart caused by compression of the leg veins by
enhanced external counterpulsation.

                                       6
<PAGE>
     The 363 patients in this cohort had  long-standing  and extensive  coronary
artery disease,  had a high prevalence of  cardiovascular  disease risk factors,
were not amenable to invasive  revascularization  procedures,  and suffered from
severe angina.  Following completion of EECP treatment, 77% decreased their CCSC
angina  class by at least one  severity  rating.  The  average  number of angina
episodes per week was greatly  reduced and many were able to discontinue the use
of  nitroglycerin  pills  designed to relieve  angina.  As in the  overall  IEPR
population,  measures  of  quality  of life were  significantly  improved  after
treatment.

     The rate of major adverse clinical events,  while somewhat more frequent in
this group of patients with significant  comorbid disease,  was characterized as
low  over  the  course  of EECP  therapy.  Exacerbation  of  heart  failure  was
significantly more frequent in patients who did not complete therapy compared to
those who did (16% vs. 0%) in patients with a previous history of heart failure.

     At two-years of follow-up,  83% remained  alive and 70% were free of death,
heart attack or invasive  revascularization  procedures  (coronary artery bypass
surgery,  angioplasty  and/or  stenting)  during that  period.  The  majority of
patients  experienced  sustained  relief of their angina and improved quality of
life.  Twenty per cent of the group  underwent  repeat EECP  therapy  during the
two-year  follow-up,  mostly due to failure to complete the  original  course of
therapy.

     A  second  phase  of  enrollment  into  the  registry   (IEPR-2)   enrolled
approximately  2,500  patients  between  2002 and 2004 and  these  patients  are
currently being followed to 2-year follow-up.  IEPR-2  incorporates  sub-studies
regarding treatment beyond 35 hours, possible predictors of response, effects on
certain aspects of peripheral  vascular  disease and sexual  dysfunction in men.
Notably,  the data set was modified in February 2003 to capture  information  on
changes in heart failure  symptom  status,  occurrence of clinical events due to
heart  failure  and  to  include  a  heart  failure-specific   quality  of  life
questionnaire in IEPR-2 patients with concomitant heart failure.

     Vasomedical  considers  the  IEPR(TM) to be a vital  source of  information
about  the   effectiveness  and  safety  of  EECP(R)  therapy  in  a  real-world
environment for the medical  community at large. To date,  eighteen  full-length
articles  reporting  data from the IEPR(TM) have been  published in  peer-review
medical journals and more than  seventy-five  abstracts have been presented at a
variety of major  cardiovascular  scientific  conferences.  For this reason,  we
continue to provide an ongoing grant to fund the registry to publicize data that
assists clinicians in delivering optimal care to patients.

     Registry data, while considered a valuable source of complementary clinical
data, is deemed by  scientific  cardiologists  and others to be less  convincing
than data from  randomized,  blinded,  clinical  trials and from  certain  other
well-controlled  clinical  study  designs.  There can be no  assurance  that the
Company  will be able to  obtain  regulatory,  reimbursement  or other  types of
approvals,  or a favorable standing in medical professional practice guidelines,
based upon results observed in patients enrolled in registries.

Other studies and publications

     A search on the term  "external  counterpulsation"  of the PubMed  database
available through the National Library of Medicine conducted on August 21, 2006,
identified one-hundred-ninety-eight (198) citations of articles published in the
medical scientific  literature,  including 28 review articles. The vast majority
of these  publications  have reported  results in patients  with chronic  stable
angina  and/or  heart  failure  treated  with EECP  therapy,  while  others have
reported  use  of the  device  in  other  cardiovascular  or  non-cardiovascular
indications.  The vast majority of these reports are generated using Vasomedical
EECP therapy systems and equipment. In summary, this body of literature contains
evidence from a variety of institutions  and  investigators  demonstrating  that
EECP therapy can provide benefit to appropriate patients in the following ways:

     o    Enhancement  of  coronary  and  peripheral   circulation,   myocardial
          perfusion, ventricular function and hemodynamics,
     o    Improvement in endothelial function and vascular reactivity
     o    Elimination or reduction of cardiac ischemia,
     o    Elimination or reduction in symptoms and improved  functional class in
          angina and heart failure,
     o    Resolution  of  reversible  ischemic  defects  found  on  quantitative
          myocardial perfusion studies,
     o    Increased  exercise  duration and increased  time to ischemic  changes
          during treadmill  exercise in angina and increased  exercise  duration
          and peak oxygen  consumption  in heart  failure in  properly  selected
          patients,
     o    Elimination or reduction in use of anti-angina medications,
     o    Improved quality of life in patients with angina and heart failure.

                                       7
<PAGE>
Strategic Initiatives

         Our short- and long-term plans are to:

          a)   reduce the cash burn and bring our cost  structure into alignment
               with current revenue in the short term by:
               i)   reducing or  eliminating  spending on all but  critical  new
                    product development and clinical research projects,
               ii)  focusing on  rebuilding  our  revenue  base  supporting  our
                    direct sales  effort and  expanding  our use of  independent
                    sales representatives, and
               iii) maintaining  tight cost  control  on all areas of  personnel
                    cost and spending.

          b)   pursue possible strategic  investments and creative  partnerships
               with  others  who  have  distinctive   competencies  or  delivery
               capabilities   for   serving  the   cardiovascular   and  disease
               management marketplace, as opportunities become available.

          c)   Increase  market  penetration in the domestic  reimbursable  user
               base for EECP therapy by:
               i)   expanding   reimbursement   to  include   coverage  for  the
                    treatment of ischemic NYHA Class II and III CHF patients,
               ii)  marketing   directly  to  third-party   payers  to  increase
                    third-party reimbursement, and
               iii) expanding  reimbursement  coverage  in the angina  market to
                    include patients with CCS Class II angina.

          d)   Increase  the  clinical  and  scientific  understanding  of  EECP
               therapy by:
               i)   completing  the  analysis  of  the  PEECH  clinical   trial,
                    publishing  the  results  in a major  peer-reviewed  medical
                    journal  and  resubmitting   data  to  insurers,   including
                    Medicare, for favorable coverage policies;
               ii)  continuing to support on a limited basis academic  reference
                    centers  in the  United  States  and  overseas  in  order to
                    accelerate the growth and prestige of EECP therapy and

          e)   Increase  awareness  of the  benefits of the EECP  therapy in the
               medical community by:
               i)   developing  campaigns to market the benefits of EECP therapy
                    directly to clinicians, third-party payers and patients;
               ii)  engaging in educational  campaigns for providers and medical
                    directors of third-party  insurers designed to highlight the
                    cost-effectiveness  and  quality-of-life  advantages of EECP
                    therapy; and
               iii) continuing  the  development  of  EECP  therapy  in  certain
                    international markets, principally through the establishment
                    of a distribution  network and the seeking of  reimbursement
                    approvals.
          f)   Maintain  development  efforts  to  improve  the EECP  system and
               expand its intellectual  property estate by filing for additional
               patents in the United States and other countries.

     These  listed  strategic  objectives  are  forward-looking  statements.  We
review,  modify and change our strategic objectives from time to time based upon
changing business conditions.  There can be no assurance that we will be able to
achieve our strategic  objectives  and even if these results are achieved  risks
and  uncertainties   could  cause  actual  results  to  differ  materially  from
anticipated  results.  To a large extent limited financial  resources  available
reduce our ability to achieve these strategic objectives. Please see the section
of this Form 10-K entitled  "Risk  Factors" for a  description  of certain risks
among others that may cause our actual results to vary from the  forward-looking
statements.

Sales and Marketing

Domestic Operations

     We sell EECP therapy  systems to  treatment  providers  such as  hospitals,
clinics and physician  private  practices in the United States  through a direct
and indirect  sales force.  Our sales force is a  combination  of employees  and
independent  sales  representatives  managed by a vice  president  of sales plus
in-house administrative support.

         The efforts of our sales organization are further supported by a staff
of clinical educators who are responsible for the onsite training of physicians
and therapists as new centers are established. This clinical applications group
is also engaged in training and certification of new personnel at each site, as
well as for updating providers on new clinical developments relating to EECP
therapy.

     Our marketing activities support physician education and physician outreach
programs,   exhibition   at  national,   international   and  regional   medical
conferences,  as well as  sponsorship  of seminars at  professional  association
meetings.  These  programs are designed to support our field sales  organization

                                       8
<PAGE>

and  increase  awareness of EECP  therapy in the medical  community.  Additional
marketing  activities include creating awareness among third-party payers to the
benefits of EECP treatment for patients suffering from CHF as well as angina.

     We employ service technicians responsible for the repair and maintenance of
EECP systems and, in some instances, on-site training of a customer's biomedical
engineering personnel.  We provide a service arrangement (usually one year) that
includes: service by factory-trained service representatives, material and labor
costs,  emergency  and  remedial  visits,  preventative  maintenance,   software
upgrades,  technical phone support and preferred  response times. We service our
customers  after  the  service   arrangement  expires  either  under  separately
purchased annual service contracts or on a fee-for-service basis.

International Operations

     We distribute our product  internationally through a network of independent
distributors. It has generally been our policy to appoint distributors exclusive
marketing  rights to EECP  therapy  systems in their  respective  countries,  in
exchange for their commitment to meet the duties and  responsibilities  required
of a distributor.  Each distribution agreement contains a number of requirements
that must be met for the distributor to retain  exclusivity,  including  minimum
performance  standards.  In most  cases,  distributors  must assist us either to
obtain  an  FDA-equivalent  marketing  clearance,  country  registration  or  to
establish  confirmatory clinical trials,  conducted by local key opinion leaders
in cardiology, required to obtain Ministry of Health approval,  certification or
reimbursement.  Each  distributor is responsible for registering the product and
obtaining  any  required  regulatory  or clinical  approvals,  supporting  local
reimbursement  efforts for EECP therapy and  maintaining  an  infrastructure  to
provide post-sales support.

     To date, revenues from international  operations have not been significant.
Revenues from non-domestic markets were 8%, 9% and 4% for the fiscal years ended
May  21,  2006,  2005,  and  2004,  respectively.  Our  international  marketing
activities  include,  among other  things,  assisting in  obtaining  national or
third-party  healthcare  insurance  reimbursement  approval and participating in
medical  conferences to create greater  awareness and acceptance of EECP therapy
by clinicians.

     International   sales  may  be   subject  to   certain   risks,   including
export/import  licenses,  tariffs,  other trade  regulations  and local  medical
regulations.  Tariff and trade  policies,  domestic and foreign tax and economic
policies,  exchange rate fluctuations and international monetary conditions have
not  significantly  affected our business to date. In addition,  there can be no
assurance  that we will be successful in maintaining  our existing  distribution
agreements or entering into any additional distribution agreements,  or that our
international distributors will be successful in marketing EECP therapy.

Competition

     Presently,  we are  aware  of at  least  four  direct  competitors  with an
external counterpulsation device on the market, namely Cardiomedics,  Inc., ACS,
Scottcare and Living Data Technologies Corporation. In addition, other companies
have received FDA 510(k) clearance for external  counterpulsation  systems since
1998,  although we have not seen these systems  commercially in the marketplace.
While we believe that these  competitors'  involvement in the market is limited,
there can be no assurance  that these  companies  will not become a  significant
competitive  factor  or  that  other  companies  will  not  enter  the  external
counterpulsation market.

     We view other  companies  engaged  in the  development  of  device-related,
biotechnology and pharmacological approaches to the management of cardiovascular
disease as potential  competitors in the marketplace as well. These include such
common and well  established  medical devices and treatments as the intra-aortic
balloon pump (IABP),  ventricular  assist devices (VAD),  coronary artery bypass
graft surgery  (CABG),  coronary  angioplasty,  mechanical  circulatory  support
(MCS),  transmyocardial laser revascularization (TMR), cardiac recovery systems,
total  artificial  hearts,  cardiac  resynchronization  devices,  ranolazine and
nesiritide   (Natrecor(R));   as  well  as  newer   technologies   currently  in
FDA-approved clinical trials such as spinal cord stimulation (SCS). There can be
no assurance that other companies will not develop new technologies or enter the
market  intended  for  EECP  therapy  systems.  Such  other  companies  may have
substantially  greater  financial,  manufacturing  and  marketing  resources and
technological  expertise than those possessed by us and may, therefore,  succeed
in  developing  technologies  or  products  that are more  efficient  than those
offered  by  Vasomedical  and that  would  render our  technology  and  existing
products obsolete or noncompetitive.

Government Regulations

     We are subject to extensive  regulation by numerous  government  regulatory
agencies,  including the FDA and similar foreign agencies. Where applicable,  we
are  required to comply  with laws,  regulations  and  standards  governing  the
development,  preclinical and clinical testing, manufacturing,  quality testing,
labeling, promotion, import, export, and distribution of our medical devices.

                                       9
<PAGE>
Device Classification

     FDA regulates  medical  devices,  including the  requirements for premarket
review,  according to their classification.  Class I devices are generally lower
risk products for which general  regulatory  controls are  sufficient to provide
reasonable  assurance  of safety and  effectiveness.  Most  Class I devices  are
exempt from the requirement of 510(k) premarket notification clearance; however,
510(k)  clearance  is necessary  prior to marketing a non-510(k)  exempt Class I
device in the United  States.  Class II devices are  devices  for which  general
regulatory  controls  are  insufficient,  but  for  which  there  is  sufficient
information  to  establish  special  controls,  such as  guidance  documents  or
standards,  to  provide  reasonable  assurance  of safety and  effectiveness.  A
premarket  notification  clearance is necessary  prior to marketing a non-510(k)
exempt Class II device in the United  States.  Class III devices are devices for
which there is insufficient  information  demonstrating that general and special
controls will provide reasonable assurance of safety and effectiveness and which
are life-sustaining,  life-supporting or implantable devices, are of substantial
importance  in  preventing  impairment  of  human  health,  or pose a  potential
unreasonable  risk of  illness  or  injury.  The FDA  generally  must  approve a
premarket  approval or PMA application  prior to marketing a Class III device in
the United States.

     A medical  device is considered by FDA to be a  preamendments  device,  and
generally not subject to premarket  review,  if it was commercially  distributed
before May 28, 1976, the date the Medical Device  Amendments of 1976 became law.
A  postamendments  device is one that was first  distributed  commercially on or
after May 28, 1976.  Postamendments  device versions of preamendments  Class III
devices are subject to the same requirements as those preamendments devices. FDA
may require a PMA for a preamendments Class III device only after it publishes a
regulation  calling for such PMA submissions.  Persons who market  preamendments
devices must submit a PMA, and have it filed by FDA, by a date  specified by FDA
in order to continue  marketing  the device.  Prior to the  effective  date of a
regulation  requiring a PMA, devices must have a cleared premarket  notification
or 510(k) for marketing.

     Certain external  counterpulsation  devices were  commercially  distributed
prior to May 28, 1976. Our external counterpulsation devices were marketed after
1976; however, they were found to be substantially equivalent to a preamendments
Class III device and  therefore  are  subject  to the same  requirements  as the
preamendments external counterpulsation devices.

Premarket Review

     The 510(k)  premarket  notification  process  requires an applicant to give
notice to FDA of its  intent to  introduce  its  device  into  commerce.  In its
premarket notification,  the applicant must demonstrate that its new or modified
medical device is  substantially  equivalent to a legally  marketed or predicate
device.  Prior to beginning  commercialization of the new or modified product it
must receive an order from the FDA  classifying  the device under section 510(k)
in the same  classification  as the predicate device,  and as a result,  the new
device will be cleared for  marketing.  Modifications  to a  previously  cleared
medical device that do not significantly  affect its safety and effectiveness or
constitute a major  change in the  intended  use can be made  without  having to
submit a new 510(k).  In February 1995, the Company received 510(k) clearance to
market the second-generation  version of its EECP therapy system, the MC2, which
incorporated a number of technological improvements over the original system. In
addition,  in December 2000, the Company received 510(k) clearance to market its
third generation system, the TS3. The FDA's clearance in these cases was for the
use of EECP  therapy in the  treatment  of  patients  suffering  from  stable or
unstable angina pectoris,  acute myocardial infarction and cardiogenic shock. In
June 2002,  the FDA granted  510(k) market  clearance for an upgraded TS3, which
incorporated  the  Company's   patented  CHF  treatment  and  oxygen  saturation
monitoring  technologies,  and provided for a new indication for the use of EECP
in CHF, which applied to all  then-current  models of the Company's EECP therapy
systems.

     Modifications   to  a  previously   cleared  medical  device  that  do  not
significantly  affect its safety and  effectiveness or constitute a major change
in the  intended  use can be made  without  having to submit a new  510(k).  FDA
publishes guidance for medical device manufacturers on the types of changes that
meet the  requirements  for a new 510(k) prior to  introduction  of a device for
marketing distribution.  Vasomedical followed FDA's guidance on when to submit a
new 510(k) for changes to a device and concluded  that the changes  incorporated
into its Model TS4 did not  require a new 510(k)  prior to its  introduction  to
market. Vasomedical subsequently obtained a 510(k) that applied to the Model TS4
and all of its models in March 2004, when it made changes to the labeling of all
of its EECP therapy systems.  In November 2004, the Company introduced its Model
Lumenair,  and again  concluded that the changes did not require a new 510(k) at
that time. There can be no assurance that the FDA will agree with  Vasomedical's
conclusions  that a new 510(k) was  unnecessary  on these  occasions or in other
similar  instances,  or that our  products  will not be subject to a  regulation
requiring a PMA for preamendments Class III external counterpulsation devices.

                                       10
<PAGE>
     If a device does not receive a clearance  order because the FDA  determines
that the device is not  substantially  equivalent to a predicate device and thus
the device automatically is considered a Class III device, the applicant may ask
the FDA to make a  risk-based  classification  to place the device in Class I or
II. However,  if a timely request for risk-based  classification is not made, or
if the FDA determines that a Class III  designation is appropriate,  an approved
PMA will be required before the device may be marketed.

     The more  rigorous  premarket  review  process is the PMA process.  The FDA
approves  a PMA  if the  applicant  has  provided  sufficient  valid  scientific
evidence to prove that the device is safe and effective for its intended use(s).
Applications for premarket  approval generally contain human clinical data. This
process is usually much more  complex,  time-consuming  and  expensive  than the
510(k)  process,  and is  uncertain.  Both  510(k)s  and  PMAs now  require  the
submission of user fees in most circumstances.

     There  can be no  assurance  that  all  the  necessary  FDA  clearances  or
approvals,  including  approval  of any PMA  required by the  promulgation  of a
regulation,  will be granted  for our  products,  future-generation  upgrades or
newly developed  products,  on a timely basis or at all. Failure to receive,  or
delays in receipt of such  clearances,  could have a material  adverse effect on
our financial condition and results of operations.

Clinical Trials

     If human  clinical  trials of a device are  required,  whether to support a
510(k)  or  PMA  application,   the  trials'  sponsor,   which  is  usually  the
manufacturer  of the device,  first must obtain the approval of the  appropriate
institutional  review boards.  If a trial is of a significant  risk device,  the
sponsor  also must obtain an  investigational  device  exemption or IDE from FDA
before the trial may begin. A significant  risk device is a device that presents
a  potential   for  serious   risk  to  the  subject  and  is  an  implant;   is
life-sustaining or life-supporting; or is for a use of substantial importance in
diagnosing,  curing,  mitigating,  or treating disease, or otherwise  preventing
impairment of human health.  For all clinical  testing,  the sponsor must obtain
informed  consent from the patients  participating in each trial. The results of
clinical  testing  that a  sponsor  undertakes  may be  insufficient  to  obtain
clearance or approval of the tested product.

Pervasive and Continuing FDA Regulation

     We are also subject to other FDA regulations  that apply prior to and after
a product is commercially  released.  These include  Current Good  Manufacturing
Practice (CGMP) requirements set forth in FDA's Quality System Regulation (QSR),
that require manufacturers to have a quality system for the design, manufacture,
packaging,  labeling,  storage,  installation  and servicing of medical  devices
intended for  commercial  distribution  in the United  States.  This  regulation
covers  various areas  including  management  and  organization,  device design,
purchase and handling of  components,  production  and process  controls such as
those  related to buildings  and  equipment,  packaging  and  labeling  control,
distribution,   installation,  complaint  handling,  corrective  and  preventive
action, servicing, and records. We are subject to periodic inspection by the FDA
for compliance with the CGMP requirements and Quality System Regulation.

     The FDA also enforces  post-marketing controls that include the requirement
to submit medical device reports to the agency when a manufacturer becomes aware
of information  suggesting that any of its marketed  products may have caused or
contributed  to  a  death  or  serious  injury,  or  any  of  its  products  has
malfunctioned  and that a recurrence  of the  malfunction  would likely cause or
contribute  to a death or  serious  injury.  The FDA  relies on  medical  device
reports to identify  product  problems and utilizes  these reports to determine,
among other things,  whether it should exercise its enforcement  powers. The FDA
also may require postmarket surveillance studies for specified devices.

     We are subject to the Federal Food,  Drug, and Cosmetic  Act's,  or FDCA's,
general controls,  including  establishment  registration,  device listing,  and
labeling  requirements.  If we fail to comply  with any  requirements  under the
FDCA, we, including our officers and employees, could be subject to, among other
things, fines, injunctions,  civil penalties, and criminal prosecution.  We also
could be subject to recalls or product corrections,  total or partial suspension
of production,  denial of premarket  notification clearance or PMA approval, and
rescission  or withdrawal of clearances  and  approvals.  Our products  could be
detained or seized, the FDA could order a recall, repair, replacement, or refund
of our devices,  and the agency could require us to notify health  professionals
and others that the devices present  unreasonable  risks of substantial  harm to
the public health.

     The  advertising  of our products is subject to  regulation  by the Federal
Trade  Commission,  or FTC. The FTC Act  prohibits  unfair or deceptive  acts or
practices in or affecting  commerce.  Violations of the FTC Act, such as failure
to have  substantiation  for product  claims,  would  subject us to a variety of
enforcement actions,  including compulsory process,  cease and desist orders and
injunctions,  which can  require,  among other  things,  limits on  advertising,
corrective advertising, consumer redress and restitution, as well as substantial
fines or other penalties.

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<PAGE>

Foreign Regulation

     In most countries to which we seek to export the EECP system, we must first
obtain  approval  from  the  local  medical  device  regulatory  authority.  The
regulatory  review  process  varies from  country to country and can be complex,
costly, uncertain, and time-consuming.

     We are also  subject to  periodic  audits by  organizations  authorized  by
foreign countries to determine  compliance with laws,  regulations and standards
that apply to the  commercialization of our products in those markets.  Examples
include auditing by a European Union Notified Body organization (authorized by a
member state's  Competent  Authority) to determine  conformity  with the Medical
Device  Directives  (MDD)  and by an  organization  authorized  by the  Canadian
government to determine conformity with the Canadian Medical Devices Regulations
(CMDR).

     There  can  be  no   assurance   that  we  will  obtain   desired   foreign
authorizations to commercially  distribute our products in those markets or that
we will comply with all laws,  regulations  and  standards  that  pertain to our
products  in those  markets.  Failure  to  receive  or delays in receipt of such
authorizations  or  determinations  of conformity  could have a material adverse
effect on our financial condition and results of operations.

Patient Privacy

     Federal  and state laws  protect  the  confidentiality  of certain  patient
health  information,  including  patient  records,  and  restrict  the  use  and
disclosure  of that  protected  information.  The U.S.  Department of Health and
Human Services (HHS) published  patient privacy rules under the Health Insurance
Portability  and  Accountability  Act of  1996  (HIPAA  privacy  rule)  and  the
regulation was finalized in October 2002. The HIPAA privacy rule governs the use
and disclosure of protected health information by "Covered  Entities," which are
(1) health plans, (2) health care clearinghouses,  and (3) health care providers
that transmit  health  information in electronic form in connection with certain
health care  transactions such as benefit claims.  Currently,  the HIPAA privacy
rule affects us only indirectly in that patient data that we access, collect and
analyze may include protected health information.  Additionally,  we have signed
some Business Associate agreements with Covered Entities that contractually bind
us to protect  protected health  information,  consistent with the HIPAA privacy
rule's requirements.  We do not expect the costs and impact of the HIPAA privacy
rule to be material to our business.

Practice Guidelines

     Medical  professional  societies  periodically issue Practice Guidelines to
their  members  and make  them  available  publicly.  The  American  College  of
Cardiology (ACC) and the American Heart  Association  (AHA) have jointly engaged
in developing  practice  guidelines since 1980 to critically evaluate the use of
diagnostic   procedures  and  therapies  in  the  management  or  prevention  of
cardiovascular   diseases.   These   guidelines   are  meant  to  "improve   the
effectiveness of care,  optimize patient outcomes and affect the overall cost of
care  favorably  by  focusing  resources  on  the  most  effective  strategies".
Recommendations incorporated into the guidelines are based upon an assessment of
the strength of evidence for or against a treatment or procedure  and  estimates
of expected  health  outcomes  stemming  from a formal  review of  peer-reviewed
published literature. These guidelines may not be updated for some time.

     The "ACC/AHA  2002  Guideline  Update for the  Management  of Patients with
Chronic  Stable   Angina"  was  last  issued  in  2003.   Comments  on  external
counterpulsation  appear in a section entitled " Recommendations for Alternative
Therapies for Chronic  Stable Angina in Patients  Refractory to Medical  Therapy
Who   Are   Not   Candidates   for   Percutaneous   Intervention   or   Surgical
Revascularization"  and include a so-called  Class IIb  recommendation.  ACC/AHA
guideline   classifications   I,  II  and  III  are  used  to   "provide   final
recommendations  for both patient evaluation and therapy" and a Class IIb rating
is   defined   as    "Usefulness/efficacy    is   less   well   established   by
evidence/opinion".

     The ACC/AHA 2005  Guidelines  for the Diagnosis  and  Management of Chronic
Heart  Failure in the Adult were issued in 2005.  External  counterpulsation  is
listed as one of the devices under  investigation  in a section  entitled "Drugs
and Interventions Under Active Investigation".

     The 2006 Comprehensive  Heart Failure Practice Guideline issued in February
2006 by the Heart  Failure  Society of America  does not include any comments on
the  use  of  external  counterpulsation  therapy  for  treating  heart  failure
patients.

     In summary,  while  evaluations of the use of EECP therapy in patients with
chronic  angina and heart  failure  continue to appear in several oral or poster
presentations  at major scientific  meetings and in  peer-reviewed  publications
each year,  there  continues to be skepticism in the cardiology  community about
its broader  use.  Additional  evidence  regarding  the efficacy of EECP therapy
continues to appear,  however the evidence  may not be  sufficient  to warrant a
modification  of practice  guidelines  to a more  favorable  recommendation  and
increased acceptance by the medical community.

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<PAGE>
Reimbursement

     In addition to  regulatory  approvals for  commercialization  by government
agencies,  reimbursement  coverage and payment rates are factors in the sales of
our products and we depend in large part on the  availability  of  reimbursement
programs.  Medicare,  Medicaid,  as well as private  health care  insurance  and
managed-care  plans  determine  eligibility for coverage of a product or therapy
based on a number of  factors,  including  the  payer's  determination  that the
product is  reasonable  and  necessary  for the  diagnosis  or  treatment of the
illness  or  injury  for  which it is  administered  according  to the  scope of
clinical evidence available, accepted standards of medical care in practice, the
product's  cost   effectiveness,   whether  the  product  is   experimental   or
investigational,  impact on health  outcomes  and  whether  the  product  is not
otherwise excluded from coverage by law or regulation.  The coverage process for
Medicare reimbursement is legislated by Congress and administered by the Centers
for  Medicare  and  Medicaid  Services  (CMS),  and is  highly  variable  in the
commercial  market.  There may be significant  delays in obtaining  coverage for
newly-approved  products, and coverage may be more limited than the purposes for
which  the  product  is  approved  or  cleared  by  FDA.  Even  when  we  obtain
authorization   from  the  FDA  or  a  foreign  authority  to  begin  commercial
distribution,  there may be limited  demand for the device  until  reimbursement
approval has been obtained from  governmental  and private  third-party  payers.
Moreover,  eligibility  for  coverage  does not  imply  that a  product  will be
reimbursed  in all cases or at a rate that allows us to market our EECP  systems
at a price  that  will  enable  us to make a profit  or even  cover  our  costs.
Reimbursement  rates  may  vary  according  to the  use of the  product  and the
clinical  setting  in which it is used,  may be based on  payments  allowed  for
lower-cost  products  that are  already  reimbursed,  may be  incorporated  into
existing  payments  for other  products or services,  and may reflect  budgetary
constraints  and/or   imperfections  in  Medicare  or  Medicaid  data.  Even  if
successful, demand for products may be driven more by the scope of peer-reviewed
evidence and  acceptance,  endorsement  by regulatory  and clinical  bodies,  or
foreign country authorities than by the reimbursement rates available.  Securing
coverage at adequate  reimbursement rates from government and third party payers
can be a time  consuming  and costly  process  that could  require us to provide
supporting scientific,  clinical, and cost-effectiveness data for the use of our
products to each payer. Our inability to promptly obtain coverage and profitable
reimbursement rates from  government-funded  and private payers for our products
could have a material  adverse  effect on our financial  condition and operating
results.

     Our reimbursement strategies are currently focused in the following primary
areas:  expanding Medicare coverage to include congestive heart failure and mild
angina,  expanding  coverage with other third-party  payers,  expanding Medicare
coverage for angina and obtaining coverage in selected international markets.

Current Medicare Coverage in Angina

     In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that  administers  the Medicare  program for more than 39 million
beneficiaries,  issued a national coverage policy under HCPCS code G0166 for the
use of the EECP therapy system. Key excerpts from the coverage read as follows:

     "Although ECP devices are cleared by the Food and Drug Administration (FDA)
     for use in treating a variety of cardiac  conditions,  including  stable or
     unstable  angina  pectoris,  acute  myocardial  infarction and  cardiogenic
     shock, the use of this device to treat cardiac conditions other than stable
     angina  pectoris  is  not  covered,  since  only  that  use  has  developed
     sufficient evidence to demonstrate its medical effectiveness."

     "for patients who have been diagnosed  with disabling  angina (class III or
     class IV,  Canadian  Cardiovascular  Society  Classification  or equivalent
     classification)  who, in the opinion of a  cardiologist  or  cardiothoracic
     surgeon, are not readily amenable to surgical interventions such as balloon
     angioplasty and cardiac bypass because:

          1.   their  condition  is  inoperable,  or at high  risk of  operative
               complications or post-operative failure;
          2.   their   coronary   anatomy  is  not  readily   amenable  to  such
               procedures; or
          3.   they have co-morbid states, which create excessive risk."

     The 2006 national  average payment rate per hourly session in the physician
office setting and the hospital  outpatient  facility is approximately  $138 and
$104,  respectively.  Reimbursement  rates vary throughout the country and range
from $113 to $231 per hourly  session.  Under the  Medicare  program,  physician
reimbursement  of the  provision  of EECP  therapy  is higher if the  therapy is
performed  in a physician  office  setting as compared to a hospital  outpatient
facility in order to reflect higher costs associated with the physician  office.
Since January 2000, the national  average payment rate has varied  considerably.

                                       13
<PAGE>
The initial  national  average payment rate for the physician office setting and
the  hospital  outpatient  facility  in 2000 was  approximately  $130 and  $112,
respectively  per hourly  session.  The average  payment rate for the  physician
office  setting  climbed  to $208 per  treatment  session in 2003  before  being
reduced  approximately  37% in 2004 to $132 per treatment  session.  In 2005 the
physician rate increased  approximately  5% and remained  unchanged in 2006. The
average payment rate for the hospital  outpatient  facility declined steadily to
2005 before increasing approximately 2% in 2006.

     In order to bill and receive payment from Medicare, an individual or entity
must be enrolled in the Medicare program for EECP therapy.  The physician office
setting and the hospital  outpatient  facility are the only  entities  currently
authorized  to receive  reimbursement  for the EECP  therapy  under the Medicare
program and reimbursement is not permitted to other individuals or entity types,
which include, but are not limited to, nurse practitioners, physical therapists,
ambulatory   surgery   centers,   nursing   homes,    comprehensive   outpatient
rehabilitation  facilities,  outpatient  dialysis  facilities,  and  independent
diagnostic  testing  facilities.  For  each of  these  provider  types  there is
statutory  authorization and accompanying  regulations that govern the terms and
conditions of Medicare program participation.

     If there were any material change in the availability of Medicare coverage,
or if the  reimbursement  level for treatment  procedures using the EECP therapy
system is determined to be inadequate,  it would adversely  affect our business,
financial  condition  and  results  of  operations.  Moreover,  we are unable to
forecast what  additional  legislation  or regulation,  if any,  relating to the
health care  industry or Medicare  coverage and payment  level may be enacted in
the future, or what effect such legislation or regulation would have on us.

Application  to Expand  Medicare  Coverage to include  Class II Angina and Class
II/III CHF

     On May 31, 2005, we submitted an  application to CMS to expand the national
coverage  policy  for  external  counterpulsation  treatment  to  patients  with
Canadian  Cardiovascular  Class II stable  angina and to patients  with New York
Heart Association  (NYHA) Class II and III stable heart failure symptoms with an
ejection  fraction less than 35%. The  application was accepted by CMS effective
June 20,  2005,  and CMS  announced  their  decision  to maintain  the  existing
coverage  as stated  prior to the  application  and not to expand it to  include
Class II Angina and Class II/III CHF on March 20, 2006.

     The application was supported by clinical evidence from several of the more
than 50 peer-reviewed journal articles, as well as the results from the recently
concluded  PEECH  clinical  trial in  order to  demonstrate  that  EECP  therapy
provides  relief of stable  angina and  congestive  heart  failure  in  selected
patients in the form of:

     o    improvement in symptoms
     o    improvement in functional capacity, i.e. ability to perform exertional
          tasks
     o    improvement in quality of life and health status

     One of the criteria  established by CMS to provide  coverage,  is to assess
the effectiveness of the therapy by reviewing the scientific  evidence published
in  peer-review  scientific  journals.  Since  the  PEECH  trial  has  yet to be
published,  CMS  indicated it had to limit the weight of evidence  provided from
the PEECH trial for  congestive  heart  failure in making its final  decision on
March 20,  2006.  We intend to  resubmit  our  application  once the PEECH trial
manuscript does get published so that CMS can provide  sufficient  weight on the
evidence provided in the study.

     Although  the  scientific  evidence  proving the safety,  efficacy and cost
effectiveness  of EECP treatment has continued to accumulate  since the original
coverage  policy was  implemented,  there can be no assurance  that the existing
evidence  is  sufficient  to support an  expansion  of EECP  therapy and CMS may
require  additional   clinical  and  scientific  evidence  to  support  expanded
reimbursement  coverage. We are unable to predict when or if CMS will approve an
expansion of reimbursement coverage for EECP therapy.

     If we are unable to obtain an adequate  national  Medicare  coverage policy
for  treatment  procedures  using EECP  therapy on  patients  with CHF,  it will
adversely  affect  our future  business  prospects.  Moreover,  we are unable to
forecast what  additional  legislation  or regulation,  if any,  relating to the
health care  industry or Medicare  coverage and payment  level may be enacted in
the future, or what effect such legislation or regulation would have on us.

Expanding Coverage with Other Third-Party Payers

     Some private  insurance  carriers  continue to  adjudicate  EECP  treatment
claims on a case-by-case  basis. Since the establishment of reimbursement by the
federal government,  however, an increasing number of these private carriers now
routinely  pay for use of EECP  therapy  for the  treatment  of angina  and have
issued positive  coverage  policies,  which are generally  similar to Medicare's

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<PAGE>
coverage  policy in  scope.  We  estimate  that over 300  private  insurers  are
reimbursing  for EECP  therapy for the  treatment  of angina  today at favorable
payment  levels  and we expect  that the number of  private  insurers  and their
related  health plans that  provide for EECP  therapy as a covered  benefit will
continue to increase.  In addition,  we are aware of two third-party payers that
have begun limited coverage of EECP therapy for the treatment of CHF.

     We intend to pursue a constructive  dialogue with many private insurers for
the  establishment of positive and expanded coverage policies for EECP treatment
that include CHF patients. If there were any material change in the availability
of third-party  private insurers or the adequacy of the reimbursement  level for
treatment procedures using the EECP therapy system it would adversely affect our
business, financial condition and results of operations. Moreover, we are unable
to forecast what additional  legislation or regulation,  if any, relating to the
health care industry or third-party private insurers coverage and payment levels
may be enacted in the future or what effect such legislation or regulation would
have on us.

Reimbursement in International Markets

     The reimbursement  environment for EECP therapy in international markets is
fragmented  and  coverage  varies  as a mix  of  available  private  and  public
healthcare  providers  may not yet be  aware  of nor  cover  this  therapy.  Our
reimbursement  strategy has been  opportunistic  and  responsive  to the selling
opportunities  presented through our distribution  partners.  During this fiscal
year our  efforts  on behalf of EECP  therapy  in both the  private  and  public
healthcare sectors of selected  international markets have been initiated by our
distributors,  in  support  of  the  therapy,  in  their  designated  territory.
Additionally,  efforts  have been  initiated  to obtain  coverage  in the public
sector in certain overseas markets;  however,  we do not anticipate an impact on
financial  performance  in the next fiscal year,  given the long lead times from
submission  to  approval  of  international   dossiers  for  each  reimbursement
authority.

Patents and Trademarks

     We own eleven US patents  including  eight utility and three design patents
that expire at various times  between 2006 and 2021.  In addition,  more than 20
foreign patents have been issued that expire at various times from 2007 to 2022.
There are six major U.S. applications pending for approval,  relating to aspects
of the Lumenair system, potential improvements, and new methods of treatment and
a notice of allowance in one of the applications  has recently been granted.  We
are pursuing these  applications in other  countries,  including  members of the
European Union. We are also planning to file other patent applications regarding
specific  enhancements to the current EECP models,  future generation  products,
and methods of treatment.  Moreover,  trademarks  have been  registered  for the
names "EECP" and "Natural Bypass".

     We pursue a policy of seeking patent protection, both in the US and abroad,
for  our  proprietary  technology.  We  believe  that  we  have a  solid  patent
foundation in the field of external counterpulsation devices and that the number
of patents and applications  demonstrates our technical leadership,  dating back
to the  mid-1980s.  Our  patent  portfolio  focuses  on the  areas  of  external
counterpulsation  control and the overall design and arrangement of the external
counterpulsation   apparatus,   including  the  console,  treatment  bed,  fluid
distribution,  and  inflatable  cuffs.  None of our current  competitors  have a
significant patent portfolio in the area of external counterpulsation devices.

     There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance. As with
any  patented  technology,  litigation  could be necessary to protect our patent
position. Such litigation can be costly and time-consuming,  and there can be no
assurance that we will be successful.  The loss or violation of our EECP patents
and trademarks could have a material adverse effect upon our business.

Employees

     As of May 31, 2006, we employed 46 full-time  and 2 part-time  persons with
12  in  direct  sales,   sales  and  clinical   applications   support,   18  in
manufacturing,  quality  control  and  technical  service,  4 in  marketing  and
customer  support,  5 in engineering,  regulatory and clinical research and 9 in
administration.  None of our  employees  are  represented  by a labor union.  We
believe that our employee relations are good.

Manufacturing

     We manufacture  our EECP therapy  systems in a single  facility  located in
Westbury,  New York.  Manufacturing  operations are conducted  under the Current
Good Manufacturing  Practice (CGMP) requirements as set forth in the FDA Quality
System  Regulation.  These  regulations  subject  us to  inspections  to  verify
compliance  and  require  us to  maintain  documentation  and  controls  for the
manufacturing and quality  activities.  ISO 13485 is the  international  quality
standard  for  medical  device  manufacturers,  based upon the ISO 9001  quality

                                       15
<PAGE>
standard  with  specific  requirements  consistent  with the FDA Quality  System
Regulation.  While  previously  we  were  certified  to  comply  with  ISO  9001
requirements,  we have applied and received ISO 13485  certification in February
2003. We are also  certified to conform with the full quality  assurance  system
requirements  of the EU Medical  Device  Directive  and can apply the CE mark to
certain  of  our  products.   Lastly,  we  are  certified  to  comply  with  the
requirements of the Canadian Medical Device Regulations (CMDR).

     We believe our manufacturing  facility,  in addition to the other warehouse
facilities  presently  under  lease,  are  adequate  to  meet  the  current  and
immediately foreseeable future demand for the production of these systems.

ITEM 1A - RISK FACTORS

     Investing in our common stock involves risk. You should carefully  consider
the following  information about these risks together with the other information
contained in this Report.  If any of the following  risks  actually  occur,  our
business  could be harmed.  This could  cause the price of our stock to decline,
and you may lose part or all of your investment.

Risks Related to Our Business

         We may not be able to continue as a going concern.

     As set forth in our  independent  auditors report for the fiscal year ended
May 31, 2006, we have suffered  recurring  losses from operations and have a net
capital  deficiency that raises  substantial doubt about our ability to continue
as a going  concern.  We currently  anticipate  that we will continue to sustain
operating  losses.  Our ability to  continue  operating,  as a going  concern is
dependent  upon achieving  profitability  or through  additional  debt or equity
financing. Achieving profitability is largely dependent on our ability to reduce
operating  costs  sufficiently as well as halting the current trend of declining
revenue.  Our  ability  to  maintain  our  current  base of  revenue  is largely
dependent  upon  restructuring  our sales and  marketing  efforts  in the angina
market  where  reimbursement  is  currently  available  and  operating in a more
efficient  manner.  If we are not able to reverse the trend of declining revenue
and  sufficiently  reduce  operating costs to generate an adequate cash flow, or
raise additional capital, we will not be able to continue as a going concern.

          We are  materially  dependent on medical  reimbursement  for treatment
     procedures  using EECP therapy on patients with congestive heart failure in
     order to achieve continued growth.

     We are currently  dependent on a single product  platform  which,  based on
current medical reimbursement policies, provides coverage for a restricted class
of heart patients. On May 31, 2005, we submitted an application to CMS to expand
the national coverage policy for external counterpulsation treatment to patients
with  Canadian  Cardiovascular  Class II stable  angina and to patients with New
York Heart  Association  (NYHA) Class II and III stable heart  failure  symptoms
with an ejection  fraction  less than 35%. The  application  was accepted by CMS
effective  June 20,  2005,  and CMS  announced  their  decision to maintain  the
existing  coverage as stated  prior to the  application  and not to expand it to
include Class II Angina and Class II/III CHF on March 20, 2006.  Since the PEECH
trial had not been published in a  peer-reviewed  journal prior to CMS issuing a
final  decision,  we intend to  resubmit  a new  application  to CMS  requesting
additional  coverage to include heart failure patients once the PEECH manuscript
is published;  however,  there can be no assurance that the results of the PEECH
trial or other clinical  evidence will be sufficient to support expansion of the
Medicare national coverage policy for EECP treatment.

     If we do not receive medical  coverage for treatment  procedures using EECP
therapy on  patients  with CHF,  it will  adversely  affect our future  business
prospects.

          Material  changes  in  the  availability  of  Medicare,   Medicaid  or
     third-party  reimbursement  at adequate price levels could adversely affect
     our business.

     Health care providers,  such as hospitals and physician private  practices,
that purchase or lease medical  devices such as the EECP therapy  system for use
on their patients generally rely on third-party  payers,  principally  Medicare,
Medicaid and private  health  insurance  plans,  to reimburse all or part of the
costs and fees associated with the procedures  performed with these devices.  If
there were any material  change in the  availability  of  Medicare,  Medicaid or
other  third-party  coverage  or the  adequacy  of the  reimbursement  level for
treatment  procedures  using the EECP therapy system,  it would adversely affect
our business,  financial condition and results of operations.  Moreover,  we are
unable to forecast what additional  legislation or regulation,  if any, relating
to the health care  industry or Medicare or Medicaid  coverage and payment level
may be enacted in the future or what effect such legislation or regulation would

                                       16
<PAGE>

have on our business. Even if a device has FDA clearance, Medicare, Medicaid and
other third-party payers may deny reimbursement if they conclude that the device
is not  "reasonable  and necessary"  according to their  criteria.  In addition,
reimbursement  may not be at, or  remain  at,  price  levels  adequate  to allow
medical  professionals  and  hospitals to realize an  appropriate  return on the
purchase of our products.

          Increased  acceptance  by  the  medical  community  is  important  for
     continued growth.

     While many  abstracts and  publications  are  presented  each year at major
scientific meetings worldwide with respect to EECP treatment efficacy,  there is
continued  skepticism  concerning EECP therapy  methodology.  The American Heart
Association and the American College of Cardiology Practice Guidelines currently
list EECP as a therapy  currently  under  investigation  for  treatment of heart
failure and have a classification  rating of IIb as a treatment for patients who
are  refractory  to medical  therapy  and are not  candidates  for  percutaneous
intervention or revascularization.  A classification rating of IIb indicates the
usefulness/efficacy    of   EECP   therapy   is   less   well   established   by
evidence/opinion.   The  medical   community   utilizes  these  guidelines  when
considering  the  various   treatment   options  for  their  patients.   Certain
cardiologists,  in cases where the EECP therapy is a viable  alternative,  still
appear to prefer percutaneous  coronary  interventions (e.g. balloon angioplasty
and stenting) and cardiac bypass surgery for their patients. Additional evidence
regarding the efficacy of EECP therapy continues to evolve, however the evidence
may not be sufficient to warrant a  modification  of these  guidelines to a more
favorable  recommendation and increased acceptance by the medical community.  We
are dependent on consistency of favorable  research  findings about EECP therapy
and  increasing  acceptance  of EECP  therapy  as a  safe,  effective  and  cost
effective  alternative to other available  products by the medical community for
continued growth.

          We face competition from other companies and technologies.

We compete  with at least  four  other  companies  that are  marketing  external
counterpulsation  devices.  We do not  know  whether  these  companies  or other
potential competitors who may be developing external  counterpulsation  devices,
may succeed in developing  technologies or products that are more efficient than
those offered by us, and that would render our technology and existing  products
obsolete  or   non-competitive.   Potential  new   competitors   may  also  have
substantially  greater  financial,  manufacturing  and marketing  resources than
those  possessed  by us. In  addition,  other  technologies  or products  may be
developed that have an entirely different approach or means of accomplishing the
intended purpose of our products.  Accordingly,  the life cycles of our products
are  difficult  to  estimate.  To compete  successfully,  we must keep pace with
technological  advancements,  respond  to  evolving  consumer  requirements  and
achieve market acceptance.

          We may not continue to receive  necessary FDA clearances or approvals,
     which could hinder our ability to market and sell our products.

     If we modify our external  counterpulsation  devices and the  modifications
significantly  affect  safety  or  effectiveness,  or if we make a change to the
intended  use,  we will be required to submit a new  premarket  notification  or
510(k) to FDA. We would be unable to market the modified device until FDA issues
a clearance for the 510(k).

     Additionally,  if FDA publishes a regulation requiring a premarket approval
application or PMA for external  counterpulsation devices, we would then need to
submit a PMA, and have it filed by the agency,  by the date  specified by FDA in
its  regulation.  A PMA requires us to prove the safety and  effectiveness  of a
device  to the  FDA.  The  process  of  obtaining  PMA  approval  is  expensive,
time-consuming,  and uncertain. If FDA were to require a PMA application, we may
be required to undertake a clinical  study,  which likely will be expensive  and
require lengthy follow-up, to demonstrate the effectiveness of the device. If we
did obtain PMA  approval,  any change  after  approval  affecting  the safety or
effectiveness of the device will require approval of a PMA supplement.

     If we offer new products that require 510(k) clearance or PMA approval,  we
will not be able to commercially distribute those products until we receive such
clearance or approval. Regulatory agency approval or clearance for a product may
not be received or may entail  limitations on the device's  indications  for use
that could limit the potential  market for any such  product.  Delays in receipt
of, or failure to obtain or maintain, regulatory clearances and approvals, could
delay or prevent our ability to market or distribute  our products.  Such delays
could have a material adverse effect on our business.

                                       17
<PAGE>
          If we are unable to comply with applicable governmental regulation, we
     may not be able to continue our operations.

     We also  must  comply  with  Current  Good  Manufacturing  Practice  (CGMP)
requirements as set forth in the Quality System  Regulation (QSR) to receive FDA
approval to market new products and to continue to market current products.  The
QSR imposes certain procedural and documentation requirements on us with respect
to manufacturing and quality assurance activities, including packaging, storage,
and record  keeping.  Our  products  and  activities  are subject to  extensive,
ongoing regulation,  including  regulation of labeling and promotion  activities
and adverse event reporting.  Also, our FDA registered facilities are subject to
inspection by the FDA and other governmental authorities.  Any failure to comply
with  regulatory  requirements  could  delay or prevent our ability to market or
distribute our products.  Violation of FDA statutory or regulatory  requirements
could result in  enforcement  actions,  such as voluntary or mandatory  recalls,
suspension  or  withdrawal  of  marketing  clearances  or  approvals,  seizures,
injunctions,  fines, civil penalties,  and criminal  prosecutions,  all of which
could have a material  adverse  effect on our  business.  Most  states also have
similar postmarket regulatory and enforcement authority for devices.

     We  cannot   predict   the   nature  of  any  future   laws,   regulations,
interpretations,  or  applications,  nor can we predict  what effect  additional
governmental  regulations or  administrative  orders,  when and if  promulgated,
would have on our  business  in the future.  We may be slow to adapt,  or we may
never adapt to changes in existing  requirements or adoption of new requirements
or policies.  We may incur significant costs to comply with laws and regulations
in the future or compliance with laws or regulations may create an unsustainable
burden on our business.

          We may not receive approvals by foreign  regulators that are necessary
     for international sales.

     Sales of medical  devices  outside the United States are subject to foreign
regulatory requirements that vary from country to country. Premarket approval or
clearance  in the United  States  does not ensure  regulatory  approval by other
jurisdictions.  If we,  or any  international  distributor,  fail to  obtain  or
maintain  required   pre-market   approvals  or  fail  to  comply  with  foreign
regulations,  foreign  regulatory  authorities  may  require us to file  revised
governmental  notifications,  cease  commercial  sales  of our  products  in the
applicable  countries or otherwise cure the problem.  Such enforcement action by
regulatory authorities may be costly.

     In order to sell our  products  within the European  Union,  we must comply
with the  European  Union's  Medical  Device  Directive.  The CE  marking on our
products attests to this  compliance.  Future  regulatory  changes may limit our
ability to use the CE mark,  and any new products we develop may not qualify for
the CE mark. If we lose this  authorization  or fail to obtain  authorization on
future products, we will not be able to sell our products in the European Union.

          We depend on management and other key personnel.

     We are  dependent  on a limited  number  of key  management  and  technical
personnel. The loss of one or more of our key employees may hurt our business if
we are unable to identify other individuals to provide us with similar services.
We do not maintain "key person" insurance on any of our employees.  In addition,
our success  depends  upon our ability to attract and retain  additional  highly
qualified  sales,   management,   manufacturing  and  research  and  development
personnel.  We face competition in our recruiting activities and may not be able
to attract or retain qualified personnel.

         We may not have adequate intellectual property protection.

     Our  patents  and  proprietary  technology  may  not  be  able  to  prevent
competition by others.  The validity and breadth of claims in medical technology
patents involve complex legal and factual questions.  Future patent applications
may  not be  issued,  the  scope  of  any  patent  protection  may  not  exclude
competitors,  and our patents may not provide competitive  advantages to us. Our
patents may be found to be invalid and other  companies  may claim  rights in or
ownership  of the patents and other  proprietary  rights held or licensed by us.
Also, our existing patents may not cover products that we develop in the future.
Moreover,  when our patents expire, the inventions will enter the public domain.
There can be no  assurance  that our  patents  will not be  violated or that any
issued  patents  will  provide  protection  that  has  commercial  significance.
Litigation may be necessary to protect our patent position.  Such litigation may
be costly  and  time-consuming,  and there can be no  assurance  that we will be
successful in such litigation.

                                       18
<PAGE>
          The loss or violation of certain of our patents and  trademarks  could
     have a material adverse effect upon our business.

     Since patent  applications  in the United States are  maintained in secrecy
until patents are issued, our patent  applications may infringe patents that may
be issued to others.  If our  products  were found to infringe  patents  held by
competitors, we may have to modify our products to avoid infringement, and it is
possible that our modified products would not be commercially successful.

         We do not intend to pay dividends in the foreseeable future.

     We do not  intend  to pay any cash  dividends  on our  common  stock in the
foreseeable future.

Risks Related to Our Industry

         Technological change is difficult to predict and to manage.

     We face the challenges that are typically faced by companies in the medical
device  field.  Our product  line has  required,  and any future  products  will
require,  substantial  development  efforts  and  compliance  with  governmental
clearance or approval requirements. We may encounter unforeseen technological or
scientific  problems  that  force  abandonment  or  substantial  change  in  the
development of a specific product or process.

          We are subject to product  liability  claims and product  recalls that
     may not be covered by insurance.

     The nature of our business exposes us to risks of product  liability claims
and product  recalls.  Medical devices as complex as ours frequently  experience
errors or failures,  especially  when first  introduced or when new versions are
released.

     We  currently  maintain  product  liability  insurance  at  $7,000,000  per
occurrence and $7,000,000 in the aggregate.  Our product liability insurance may
not be  adequate.  In the future,  insurance  coverage  may not be  available on
commercially reasonable terms, or at all. In addition,  product liability claims
or  product  recalls  could  damage  our  reputation  even if we  have  adequate
insurance coverage.

         We do not know the effects of healthcare reform proposals.

     The healthcare  industry is undergoing  fundamental  changes resulting from
political,   economic  and   regulatory   influences.   In  the  United  States,
comprehensive  programs  have  been  suggested  seeking  to  increase  access to
healthcare for the uninsured,  control the escalation of healthcare expenditures
within the  economy  and use  healthcare  reimbursement  policies to balance the
federal budget.

     We expect  that the United  States  Congress  and state  legislatures  will
continue to review and assess various  healthcare reform  proposals,  and public
debate of these issues will likely continue. There have been, and we expect that
there will continue to be, a number of federal and state  proposals to constrain
expenditures  for medical  products and services,  which may affect payments for
products such as ours. We cannot predict which, if any of such reform  proposals
will be adopted and when they might be effective,  or the effect these proposals
may have on our business.  Other countries also are  considering  health reform.
Significant changes in healthcare systems could have a substantial impact on the
manner in which we  conduct  our  business  and could  require  us to revise our
strategies.

Risks Related to Stock Exchange and SEC Regulation

          We were de-listed  from Nasdaq and may be subject to regulations  that
     could reduce our ability to raise funds.

     By letter dated May 2, 2005, we received written  notification  from Nasdaq
that the bid price of our common stock for the last 30 consecutive business days
had closed below the minimum $1.00 per share  required for  continued  inclusion
under  Marketplace  Rule 4310(c) (4) (the Rule). In accordance with  Marketplace
Rule 4310 (c) (d), we were  provided an initial  period of 180 calendar  days to
regain  compliance  plus an automatic  extension  for  additional  period of 180
calendar days since we met the Nasdaq Capital Markets  initial listing  criteria

                                       19
<PAGE>

except for the bid price  requirement.  During this period our common  stock did
not rise above the $1.00 per share minimum and on May 26, 2006, our common stock
was delisted and our stock is currently traded on the Over-the-Counter  Bulletin
Board.

     As a result of our  de-listing  from the Nasdaq  Capital  Market due to low
stock price, we may become subject to special rules,  called "penny stock" rules
that impose additional sales practice  requirements on  broker-dealers  who sell
our common  stock.  Penny stocks  generally are equity  securities  that are not
registered on certain national securities exchanges or quoted by Nasdaq and have
a price per share of less than $5.00. The rules require, among other things, the
delivery,  prior to the transaction,  of a disclosure  schedule  required by the
Securities and Exchange  Commission relating to the market for penny stocks. The
broker-dealer   also  must  disclose  the   commissions   payable  both  to  the
broker-dealer and the registered  representative  and current quotations for the
securities,  and  monthly  statements  must  be  sent  disclosing  recent  price
information.

     In the event that our common stock becomes  characterized as a penny stock,
our market  liquidity could be severely  affected.  The regulations  relating to
penny stocks could limit the ability of  broker-dealers to sell our common stock
and thus the  ability of  purchasers  of our common  stock to sell their  common
stock in the secondary market.

     Additionally,  Nasdaq's delisting of our common stock could have an adverse
effect on our ability to raise additional equity capital.

         We are subject to stock exchange and SEC regulation.

     Recent  Sarbanes-Oxley  legislation  and stock  exchange  regulations  have
increased  disclosure control,  financial  reporting,  corporate  governance and
internal control  requirements  that will increase the  administrative  costs of
documenting  and auditing  internal  processes,  gathering  data,  and reporting
information.  Our inability to comply with the requirements would  significantly
impact our market valuation.

         Our common stock is subject to price volatility.

     The market price of our common stock historically has been and may continue
to be highly volatile.  Our stock price could be subject to wide fluctuations in
response to various factors beyond our control, including:

     o    medical reimbursement
     o    quarterly variations in operating results;
     o    announcements of technological innovations, new products or pricing by
          our competitors;
     o    the rate of adoption by physicians of our  technology  and products in
          targeted markets;
     o    the timing of patent and regulatory approvals;
     o    the timing and extent of technological advancements;
     o    results of clinical studies;
     o    the sales of our common stock by affiliates or other shareholders with
          large holdings; and
     o    general market conditions.

     Our future operating  results may fall below the expectations of securities
industry analysts or investors. Any such shortfall could result in a significant
decline in the market price of our common stock.  In addition,  the stock market
has experienced significant price and volume fluctuations that have affected the
market price of the stock of many medical  device  companies and that often have
been  unrelated to the  operating  performance  of such  companies.  These broad
market fluctuations may directly influence the market price of our common stock.

Additional Information

     We are subject to the reporting  requirements under the Securities Exchange
Act of 1934 and are required to file reports and information with the Securities
and Exchange Commission (SEC),  including reports on the following forms: annual
report on Form 10-K,  quarterly  reports on Form 10-Q,  current  reports on Form
8-K, and  amendments  to those  reports  files or furnished  pursuant to Section
13(a) or 15(d) of the Securities Act of 1934.

ITEM 2 - PROPERTIES

     We own our 18,000 square foot  headquarters and  manufacturing  facility at
180 Linden Avenue,  Westbury,  New York 11590. We currently lease  approximately
3,500 square feet of additional  warehouse space under an operating lease with a

                                       20
<PAGE>
non-affiliated  landlord that expires in September 2006,  which we do not intend
to renew.  We believe that our current  facility is adequate to meet our current
needs and should continue to be adequate for the immediately foreseeable future.

ITEM 3 - LEGAL PROCEEDINGS

     There were no material legal proceedings under applicable rules.

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

     There were no matters  submitted to a vote of security  holders  during the
fourth quarter of the fiscal year.

                                       21
<PAGE>
                                     PART II

ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY,  RELATED STOCKHOLDER MATTERS AND
         ISSUER PURCHASES OF EQUITY SECURITIES

     Our common stock currently  trades on the  Over-the-Counter  Bulletin Board
under the symbol  VASO.OB.  On May 26, 2006,  our common stock ceased trading on
the Nasdaq  Capital  Market tier of the Nasdaq Stock Market and began trading on
the NASD Pink Sheets. Effective June 20, 2006, our common stock began trading on
the Over the Counter  Bulletin  Board  (OTCBB).  The number of record holders of
common  stock as of August 1,  2006,  was  approximately  1,100,  which does not
include  approximately  27,600  beneficial  owners of shares held in the name of
brokers or other nominees.  The table below sets forth the range of high and low
trade prices of the common stock for the fiscal periods specified.
<TABLE>
<CAPTION>
                             Fiscal 2006                Fiscal 2005
                          High          Low          High           Low
<S>                       <C>          <C>           <C>           <C>
First Quarter             $0.88        $0.53         $1.27         $0.83
Second Quarter            $0.65        $0.38         $1.25         $0.90
Third Quarter             $0.53        $0.16         $1.52         $0.90
Fourth Quarter            $0.35        $0.10         $1.98         $0.57
</TABLE>

     The last bid price of the  Company's  common stock on August 14, 2006,  was
$0.10 per share.

De-listing from the Nasdaq Capital Market

     By letter dated May 2, 2005, we received written  notification  from Nasdaq
that the bid price of our common stock for the last 30 consecutive business days
had closed below the minimum $1.00 per share  required for  continued  inclusion
under  Marketplace  Rule 4310(c) (4) (the Rule). In accordance with  Marketplace
Rule 4310 (c) (d), we were  provided an initial  period of 180 calendar  days to
regain  compliance  plus an automatic  extension  for  additional  period of 180
calendar days since we met the Nasdaq Capital Markets  initial listing  criteria
except for the bid price  requirement.  During this period our common  stock did
not rise above the $1.00 per share minimum and on May 26, 2006, our common stock
was delisted and our stock is currently traded over-the-counter.

     As a result of our  de-listing  from the Nasdaq  Capital  Market due to low
stock price,  we may become subject to special  rules,  called penny stock rules
that impose additional sales practice  requirements on  broker-dealers  who sell
our common stock. The rules require, among other things, the delivery,  prior to
the  transaction,  of a  disclosure  schedule  required  by the  Securities  and
Exchange  Commission  relating to the market for penny stocks. The broker-dealer
also must disclose the  commissions  payable both to the  broker-dealer  and the
registered representative and current quotations for the securities, and monthly
statements must be sent disclosing recent price information.

     The  regulations  relating  to penny  stocks  could  limit the  ability  of
broker-dealers  to sell our common stock and thus the ability of  purchasers  of
our common stock to sell their common stock in the secondary market.

     Additionally,  Nasdaq's delisting of our common stock could have an adverse
effect our ability to raise additional equity capital..

Dividend Policy

     We have never paid any cash dividends on our common stock.  While we do not
intend  to pay  cash  dividends  in the  foreseeable  future,  payment  of  cash
dividends,  if any, will be dependent upon our earnings and financial  position,
investment  opportunities and such other factors as the Board of Directors deems
pertinent.  Stock  dividends,  if any, also will be dependent on such factors as
the Board of Directors deems pertinent.

Sale of Convertible Preferred Securities.

     On July 19,  2005,  we entered into a Securities  Purchase  Agreement  that
provided us with gross proceeds of $2.5 million  through a private  placement of
preferred stock with M.A.G.  Capital,  LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the  "Investors").  The  agreement  provided for a private  placement of 25,000
shares of our Series D Preferred  Stock at $100 per share plus  warrants.  As of
February 7, 2006,  all of the preferred  shares had been  converted  into common
shares  and  there  are no  preferred  shares  currently  outstanding.

                                       22
<PAGE>

ITEM 6 -

SELECTED FINANCIAL DATA

The following table summarizes selected financial data for each of the five
years ended May 31 as derived from our audited consolidated financial
statements. These data should be read in conjunction with our consolidated
financial statements, related notes and other financial information.
<TABLE>
<CAPTION>
                                                                         Fiscal Year Ended May 31,
                                                    2006           2005            2004           2003            2002
<S>                                               <C>            <C>             <C>            <C>             <C>
Statements of Earnings
Revenues                                          $10,942,997    $15,095,778     $22,207,037    $24,823,619     $34,830,471
Cost of sales and services                          4,774,329      5,504,535       7,590,103      9,251,221      10,538,731
                                                -------------- -------------- --------------- -------------- ---------------
   Gross profit                                     6,168,668      9,591,243      14,616,934     15,572,398      24,291,740

Selling, general & administrative expenses          7,865,533     12,006,774      12,910,997     13,714,913      13,686,958
Research and development expenses                   1,805,667      3,064,683       3,748,389      4,544,822       5,112,258
Provision for doubtful accounts                       110,317         11,084       1,296,759      3,728,484       1,304,000
Interest and financing costs                           81,662        105,232         132,062        186,574          98,140
Interest and other income, net                       (75,508)       (74,153)        (99,393)      (176,724)       (249,722)
                                                -------------- -------------- --------------- -------------- ---------------
                                                    9,787,671     15,113,620      17,988,814     21,998,069      19,951,634
                                                -------------- -------------- --------------- -------------- ---------------
Earnings (loss) before income taxes               (3,619,003)    (5,522,377)     (3,371,880)    (6,425,671)       4,340,106

Income tax (expense) benefit, net                 (7,082,138)       (39,661)        (50,640)      1,634,688     (1,554,000)
                                                -------------- -------------- --------------- -------------- ---------------
Net earnings (loss)                              (10,701,141)    (5,562,038)     (3,422,520)    (4,790,983)       2,786,106
Preferred stock dividend                            (877,870)             --              --             --              --
                                                -------------- -------------- --------------- -------------- ---------------
Net loss attributable to common shareholders    $(11,579,011)   $(5,562,038)    $(3,422,520)   $(4,790,983)      $2,786,106
                                                ============== ============== =============== ============== ===============


Net earnings (loss) per common share
    - basic                                           $(0.19)        $(0.10)         $(0.06)        $(0.08)           $0.05
                                                ============== ============== =============== ============== ===============
    - diluted                                         $(0.19)        $(0.10)         $(0.06)        $(0.08)           $0.05
                                                ============== ============== =============== ============== ===============
Weighted average common shares
  outstanding - basic                              61,351,323     58,547,574      57,981,963     57,647,032      57,251,035
                                                ============== ============== =============== ============== ===============
              - diluted                            61,351,323     58,547,574      57,981,963     57,647,032      59,468,092
                                                ============== ============== =============== ============== ===============

Balance Sheet Data
Cash, cash equivalents, and certificates of
   deposit                                         $2,385,778     $2,747,967      $7,545,589     $5,222,847      $2,967,627
Working capital                                    $2,867,288     $3,932,769      $9,771,870    $11,478,092     $17,225,434
Total assets                                       $7,912,040    $25,361,470     $33,023,615    $35,327,550     $41,418,258
Long-term debt                                       $853,189       $947,597      $1,092,837     $1,177,804      $1,072,716
Stockholders' equity (1)                           $3,166,156    $19,162,797     $24,594,169    $27,319,302     $31,602,604

-------------------
<FN>
(1) No cash dividends on common stock were declared during any of the above periods.
</FN>
</TABLE>

                                       23
<PAGE>

Summary of quarterly financial data (unaudited)

     The following is a summary of the Company's  unaudited  quarterly operating
results for the years ended May 31, 2006 and 2005.
<TABLE>
<CAPTION>
                                                            Three months ended
                      ------------------------------------------------------------------------------------------------
(in 000s except
earnings (loss) per     May 31,     Feb. 28,     Nov. 30,   Aug. 31,    May 31,      Feb. 28,     Nov. 30,    Aug. 31,
share data)              2006         2006        2005        2005        2005         2005         2004       2004
--------------------- ----------- ----------- ------------ ------------ ----------- ----------- ----------- ----------
<S>                     <C>         <C>          <C>         <C>          <C>         <C>          <C>        <C>
Revenues                $1,885      $2,842       $2,680      $3,536       $3,848      $2,964       $3,462     $4,821
Gross profit              $859      $1,614       $1,582      $2,113       $2,344      $1,800       $2,288     $3,160
Net loss
  attributable to
  common
  shareholders           $(504)      $(695)     $(8,682)    $(1,698)     $(1,001)    $(2,027)     $(1,610)     $(924)
Loss per
  share - basic         $(0.01)     $(0.01)      $(0.15)     $(0.03)      $(0.02)     $(0.03)      $(0.03)    $(0.02)
        - diluted       $(0.01)     $(0.01)      $(0.15)     $(0.03)      $(0.02)     $(0.03)      $(0.03)    $(0.02)
Weighted average
  common shares
  outstanding -
        - basic         65,173      62,162       59,421       58,616      58,553      58,553       58,553      58,532
        - diluted       65,173      62,162       59,421       58,616      58,553      58,553       58,553      58,532
</TABLE>

                                       24
<PAGE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

     This  Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of Operations contains descriptions of our expectations regarding future
trends  affecting  our  business.  These forward  looking  statements  and other
forward-looking  statements  made  elsewhere in this document are made under the
safe harbor provisions of the Private Securities  Litigation Reform Act of 1995.
Please read the section titled "Risk Factors" in "Item One - Business" to review
certain conditions, among others, which we believe could cause results to differ
materially from those contemplated by the forward-looking statements.

     Forward-looking  statements are identified by words such as  "anticipates",
"believes", "could", "estimates", "expects", "feels", "intends", "may", "plans",
"potential", and "projects" and similar expressions. In addition, any statements
that  refer to our  plans,  business  plan,  expectations,  strategies  or other
characterizations   of  future  events  or  circumstances  are   forward-looking
statements. Such forward-looking statements are based on our beliefs, as well as
assumptions made by and information currently available to us. Among the factors
that could cause actual  results to differ  materially  are the  following:  the
effect of business and economic  conditions,  the effect of the dramatic changes
taking  place in the  healthcare  environment;  the impact of medical  insurance
reimbursement  policies  including  the continued  inability to obtain  Medicare
reimbursement  for heart failure patients;  competitive  procedures and products
and their pricing;  unexpected  manufacturing problems;  unforeseen difficulties
and delays in the  conduct of  clinical  trials  and other  product  development
programs;  the actions of regulatory  authorities and third-party  payers in the
United  States  and  overseas;  uncertainties  about the  acceptance  of a novel
therapeutic  modality by the medical  community;  and the risk factors  reported
from time to time in our SEC  reports,  including  the ability of the Company to
continue  as  a  going   concern.   We   undertake  no   obligation   to  update
forward-looking statements as a result of future events or developments.

         The following discussion should be read in conjunction with financial
statements and notes thereto included in this Annual Report on Form 10-K.

Overview

     Vasomedical,  Inc.  incorporated  in  Delaware  in July  1987 is  primarily
engaged in designing,  manufacturing,  marketing and supporting EECP(R) external
counterpulsation systems based on our proprietary technology.  EECP therapy is a
non-invasive,   outpatient   therapy  for  the  treatment  of  diseases  of  the
cardiovascular  system.  The therapy serves to increase  circulation in areas of
the heart  with less than  adequate  blood  supply and has been shown to improve
systemic vascular function. We provide hospitals and physician private practices
with  EECP  therapy  systems,  treatment  guidance,  and a  staff  training  and
equipment  maintenance  programs  designed to provide optimal patient  outcomes.
EECP  is  a   registered   trademark   for   Vasomedical's   enhanced   external
counterpulsation systems.

     We have Food and Drug  Administration  (FDA)  clearance  to market our EECP
therapy for use in the treatment of stable and unstable angina, congestive heart
failure (CHF), acute myocardial  infarction,  and cardiogenic shock, however our
current  marketing  efforts are limited to the  treatment  of stable  angina and
congestive  heart failure  indications.  Within the stable  angina  indications,
Medicare and other  third-party  payers  currently  reimburse  for stable angina
patients with moderate to severe symptoms who remain  symptomatic on medications
and  not  candidates  for  invasive  procedures.  Some  CHF  patients  are  also
reimbursed under the same criteria, provided their primary symptoms are angina.

     We sponsored a pivotal study to demonstrate the efficacy of EECP therapy in
the most prevalent types of heart failure patients.  This study,  known as PEECH
(Prospective  Evaluation of EECP in Congestive  Heart Failure),  was intended to
provide  additional  clinical  data in  order to  support  our  application  for
expanded  Medicare  national  coverage policy for the use of EECP therapy in the
treatment of CHF.  The  preliminary  results of the trial were  presented at the
American College of Cardiology  scientific sessions in March 2005, and we expect
the  results of the PEECH  clinical  trial to be  published  in a  peer-reviewed
journal  within the next few months.  On June 20, 2005, the Centers for Medicare
and Medicaid  Services (CMS) accepted our application  for expanded  coverage of
EECP  therapy  to include  CHF as a primary  indication,  as well as  additional
patients with angina. However, on March 20, 2006, CMS issued a final decision to
maintain  the  existing  coverage  with no changes  for  expansion  of  external
counterpulsation  therapy. The fact that the results of the PEECH trial have not
been  published to date factored into CMS'  decision,  however,  it is not clear
whether CMS will decide otherwise once the results are published.

     We have  incurred  declines  in  revenue  and  have  sustained  significant
operating  losses  during the last three fiscal years and  currently  anticipate
that we will  continue  to sustain  operating  losses.  Our  ability to continue
operating  as a going  concern is  dependent  upon  achieving  profitability  or
through  additional debt or equity  financing.  We currently  anticipate that we
will continue to sustain  operating losses.  Achieving  profitability is largely
dependent  on our  ability to reduce  operating  costs  sufficiently  as well as
halting the current  trend of  declining  revenue.  Our ability to maintain  our

                                       25
<PAGE>

current base of revenue is largely  dependent upon  restructuring  our sales and
marketing  efforts  in  the  angina  market  where  reimbursement  is  currently
available  and  operating  in a more  efficient  manner.  If we are not  able to
reverse the trend of declining  revenue and sufficiently  reduce operating costs
to generate an adequate cash flow, or raise additional  capital,  we will not be
able to continue as a going concern.

     In  January  2006 in  order to  reduce  the cash  burn and  bring  our cost
structure  more into  alignment  with  current  revenue,  we initiated a company
restructuring,  to reduce  personnel and spending on marketing  and  development
projects.  We anticipate that the  restructuring  will reduce  manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition,  in April 2006,  the board of directors  elected to defer meeting fees
and certain senior  executives  elected to defer  approximately  $0.4 million in
annual  salary  compensation.  We believe that these steps to conserve cash will
provide the Company with the opportunity to rebuild sales to a profitable  level
and/or explore strategic opportunities.

     Based on the continuation of current revenue levels and the  implementation
of our restructuring  plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.

     In the event that additional capital is required, we may seek to raise such
capital  through public or private equity or debt  financings or other means. We
may not be able to obtain additional  financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further  scale back our  operations,  research,  marketing  or sales  efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish  rights to technologies or products.  Future
capital funding, if available,  may result in dilution to current  shareholders,
and new investors could have rights superior to existing stockholders.

Results of Operations

Fiscal Years Ended May 31, 2006 and 2005

     Net  revenue  from sales,  leases and  service of our EECP  systems for the
fiscal  year  ended May 31,  2006 and 2005,  was  $10,942,997  and  $15,095,778,
respectively,  which  represented  a decline of $4,152,781 or 28%. We reported a
net  loss  attributable  to  common  shareholders  of  $11,579,011  compared  to
$5,562,038  for the fiscal year ended May 31, 2006 and 2005,  respectively.  Our
net loss per  common  share was $0.19 for the fiscal  year  ended May 31,  2006,
compared  to a net loss of $0.10  per share for the  fiscal  year  ended May 31,
2005.  The  increase  in net loss is  primarily  due to the  establishment  of a
$7,093,000  valuation  reserve in the fiscal  year 2006  second-quarter  for the
then-remaining carrying value of the deferred tax asset.

     The gross profit  declined to  $6,168,668 or 56% of revenues for the fiscal
year ended May 31,  2006,  compared to  $9,591,243  or 64% of  revenues  for the
fiscal year ended May 31, 2005. The decline in gross profit  primarily  reflects
the reduced sales volume,  however the loss from  operations  was reduced in the
fiscal  year  ended  May 31,  2006  to  $3,612,849  compared  to the  loss  from
operations in fiscal year 2005 of $5,491,298.  Total  operating  expenses in the
fiscal  year  ended  May 31,  2006 and 2005  were  $9,781,517  and  $15,082,541,
respectively  reflecting a decline of $5,301,024 due primarily to two major cost
savings measures initiated in May 2005 and January 2006.

Revenues

     Revenue from equipment sales declined  approximately  41% to $6,820,980 for
the  twelve-month  period ended May 31, 2006 as compared to $11,516,883  for the
same period for the prior year. The decline in equipment  sales is due primarily
to a 41% decline in the number of EECP system shipments in both the domestic and
international  markets. The lower equipment sales volume was partially offset by
a 1%  improvement  in average  sales  prices.  A favorable  mix of new equipment
versus used  equipment  was the primary  cause of the increase in average  sales
prices as new EECP system  shipments  increased to 79% of total system shipments
in fiscal 2006 compared to 68% in fiscal 2005.

     Revenue from  shipments of EECP  systems in the  domestic  market  declined
approximately  41%. We believe the decline in domestic units shipped reflects an
over  capacity of EECP  systems due to weakened  demand for EECP  therapy in the
angina market,  coupled with  increased  competition  from surgical  procedures,
mainly the use of  drug-eluting  stents  coupled with an unstable  reimbursement
environment due to our inability to expand reimbursement coverage to include the
heart failure indication as well as the decline in average  reimbursement  rates
in recent years.  Additionally,  limited financial resources resulted in reduced
sales  coverage,  product  promotions and marketing  support.  Although  average
domestic  selling  prices for new and used systems  improved  compared to fiscal
2005,  the  average  selling  prices for new  systems  shipments  in fiscal 2006
declined  approximately  6%  compared to fiscal  2005.  We  anticipate  that the
prevailing  trend of declining  prices will continue in the immediate  future as
our  competition  attempts  to capture  greater  market  share  through  pricing
discounts.

                                       26
<PAGE>

     Our  revenue  from  the  sale of  EECP  systems  and  related  products  to
international  distributors  in the fiscal  year ended May 31,  2006,  decreased
approximately  39% to $808,000  compared to $1,316,000 in the same period of the
prior year, as a result of the lower system volume and lower selling prices.

     The above decline in revenue from equipment sales was partially offset by a
15% increase in revenue from  equipment  rental and services for the fiscal year
ended May 31, 2006,  compared to the same twelve-month period in the prior year.
Revenue from equipment  rental and services  represented 38% of total revenue in
fiscal  2006  compared to 24% in fiscal  2005.  The  increase  in both  absolute
amounts and percentage of total revenue  resulted  primarily from an increase of
approximately  37% in  service  related  revenue.  The  higher  service  revenue
reflects an increase in service  labor and spare parts,  plus greater  marketing
focus on the sale of extended  service  contracts as the installed  base of EECP
therapy systems  continues to grow. Rental revenue declined  approximately  58%,
partially  offsetting the above. The decline was primarily due to a multi-system
customer defaulting on its rental payments during fiscal 2005; consequently,  we
shifted  to a cash  basis for  revenue  recognition  for this  customer  and our
equipment was eventually returned.

Gross Profit

     The gross profit  declined to  $6,168,668 or 56% of revenues for the fiscal
year ended May 31,  2006,  compared to  $9,591,243  or 64% of  revenues  for the
fiscal year ended May 31, 2005.  Gross profit  margin as a percentage of revenue
in fiscal year 2006  decreased  compared to the same period of the prior  fiscal
year  despite  the  improvement  in average  selling  prices,  mainly due higher
overhead absorption costs associated with reduced production volumes in the last
four fiscal quarters.  In addition,  adoption of SFAS No. 151 lowered the amount
of fixed overhead costs absorbed into inventory in fiscal 2006 by $256,000 or 2%
of revenue.  Partially  offsetting  the decline was an  improvement in the gross
profit margins  associated with accessory  revenues,  reflecting  higher average
selling  prices.  The decline in gross profit when compared to the prior year in
absolute dollars is a direct result of the lower sales volume.

     Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their  respective  average selling prices,  the mix of EECP
therapy systems sold,  rented or placed during the period,  the ongoing costs of
servicing  such units,  and certain  fixed period costs,  including  facilities,
payroll and insurance.  Gross profit margins are generally less on  non-domestic
business  due to the use of  distributors  resulting  in lower  selling  prices.
Consequently,  the gross profit  realized  during the current  period may not be
indicative of future margins.

Selling, General and Administrative

     Selling, general and administrative ("SG&A") expenses for the twelve-months
ended May 31, 2006 and 2005,  were $7,865,533 or 72% of revenues and $12,006,774
or 80% of  revenues,  respectively  reflecting  an  decrease  of  $4,141,241  or
approximately  35%. The decrease in SG&A expenditures in fiscal 2006 compared to
fiscal 2005 resulted  primarily  from decreased  expenditures  in direct selling
activities  and  clinical  applications  support  of  $1,487,420  and  $420,775,
respectively,  reflecting fewer personnel and associated travel plus lower sales
commission due the reduced sales volume. Marketing expenses declined $1,569,356,
due to reduced personnel plus lower market research, product promotion and trade
show costs. Administrative expenses declined $659,327 primarily reflecting lower
accounting costs.

Research and Development

     Research and  development  ("R&D")  expenses  totaled  $1,805,667 or 17% of
revenues  for the fiscal year ended May 31, 2006,  a decrease of  $1,259,016  or
41%,  from the fiscal year ended May 31, 2005, of $3,064,683 or 20% of revenues.
The decrease is primarily  attributable to fewer engineering personnel and lower
new product  development costs following the completion of the fourth generation
EECP therapy system,  the Lumenair,  plus reduced spending for clinical research
and  regulatory  affairs  following  completion of the PEECH  clinical  trial in
fiscal year 2005.

Provision for Doubtful Accounts

     During the fiscal year ended May 31, 2006,  we increased  the provision for
doubtful  accounts  by  $110,317  or 1% of revenue as compared to an increase of
$11,094  during  the fiscal  year ended May 31,  2005.  Collection  of  doubtful
accounts  from the previous  fiscal year reduced the net  provision for doubtful
accounts expense in fiscal 2005.

                                       27
<PAGE>

Interest Expense and Financing Costs

     Interest  expense and  financing  costs  decreased to $81,662 in the fiscal
year  ended  May 31,  2006,  from  $105,232  for the  fiscal  year 2005 due to a
declining  principal  balance.  Interest expense primarily  reflects interest on
loans  secured  to  refinance  the  November  2000  purchase  of  the  Company's
headquarters,  manufacturing and warehouse facility, as well as on loans secured
to finance the cost and implementation of a new management information system.

Interest and Other Income, Net

     Interest  and other income for the fiscal year ended May 31, 2006 and 2005,
were $75,508 and $74,153,  respectively.  Lower average cash, cash  equivalents,
and  certificates  of deposit  balances  were  invested  during  fiscal  2006 as
compared to the prior year. This was offset by increases in interest rates.

Income Tax Expense, Net

     During the fiscal year ended May 31, 2006 and 2005, we recorded  income tax
expense of  $7,082,138  and $39,661,  respectively.  The fiscal 2006 tax expense
consists mainly of $7,093,000 in additional valuation allowance provided for the
deferred  tax asset in the second  fiscal  quarter.  The income tax  expense for
fiscal 2006 does not include  $7,489,000  added to the  deferred  tax  valuation
allowance in the second quarter of fiscal 2006 for tax benefits  associated with
prior years' exercises of stock options and warrants, which was charged directly
to additional paid-in capital.

     As of May 31, 2005, we had recorded  deferred tax assets of $14,582,000 net
of a $3,774,000  valuation allowance related to the anticipated  recovery of tax
loss  carryforwards.  On December  20,  2005,  Centers for Medicare and Medicaid
Services  (CMS)  issued  a  Proposed  Decision  Memorandum  (PDM)  for  External
Counterpulsation   in   response   to   Vasomedical's   application   to  expand
reimbursement  coverage to include Canadian  Cardiovascular Society (CCSC) Class
II angina and New York Heart  Association  (NYHA) Class II/III  congestive heart
failure  (CHF).  The PDM stated that the  evidence  was not adequate to conclude
that external  counterpulsation  therapy is  reasonable  and necessary to expand
reimbursement  coverage  to CCSC Class II angina  and NYHA Class  II/III CHF and
that current  coverage for CCSC class III/IV  refractory  angina would remain in
effect. Consequently, at the end of the second fiscal quarter of fiscal 2006, we
concluded that,  based upon the weight of available  evidence,  it was no longer
"more likely than not" that the net deferred tax asset of  $14,582,000  would be
realized,  and added  $14,582,000  to the  valuation  allowance to bring the net
deferred tax asset  carrying  value to zero.  On March 20, 2006,  CMS issued its
final decision, which upheld the PDM.

     As of May 31, 2006, the recorded deferred tax asset was $19,559,458,  which
was offset by a valuation allowance of the same amount.

Fiscal Years Ended May 31, 2005 and 2004

     We generated  revenues from the sale, lease and service of our EECP therapy
systems of  $15,095,778  and  $22,207,037  for the years  ended May 31, 2005 and
2004,  respectively,  reflecting a decrease of  $7,111,259  or 32%. Our loss was
$5,562,038  or $0.10 per share and  $3,422,520  or $0.06 per share for the years
ended May 31, 2005 and 2004, respectively.

Revenues

     Revenues from equipment sales declined approximately 40% to $11,516,883 for
the year ended May 31, 2005, as compared to $19,302,593  for the prior year. The
decline in equipment  sales is due primarily to a 41% decline in domestic  units
shipped,  a 5% decline in the average  sales  prices of new EECP systems sold in
the domestic market, and an unfavorable  product mix reflecting a higher portion
of used versus new equipment  shipments.  Used systems had lower average selling
price compared to new systems, and experienced a 29% decrease in average selling
price when compared to used systems sold in the domestic market in fiscal 2004.

     Our revenue from the sale of EECP systems to international distributors for
the year ended May 31, 2005, increased  approximately 64% to $1,315,985 compared
to $801,600  in the prior year  reflecting  increased  volume of new systems and
improved average selling prices.

         The above decline in revenue from domestic equipment sales was
partially offset by a 23% increase in revenue from equipment rental and services
for year ended May 31, 2005, as compared to the prior year. Revenue from
equipment rental and services represented 24% of total revenue in fiscal 2005
compared to 13% in fiscal 2004. The increase in both absolute amounts and
percentage of total revenue resulted primarily from an increase of approximately
30% in service related revenue. The higher service revenue reflects an increase

                                       28
<PAGE>
in service, spare parts and consumables as a result of the continued growth of
the installed base of EECP systems plus greater marketing focus on the sale of
extended service contracts. Rental revenue declined approximately 15% following
the termination of several short-term rental agreements partially offsetting the
above.

     Reimbursement  continues  to play a critical  role in the  adoption of EECP
therapy.  Medicare  dropped the payment rates 34% from $208 per hour to $137 per
hour for  physicians  at the  beginning  of  calendar  year  2004.  The  current
reimbursement  rate is now set at the rates near when the product first received
Medicare coverage in 2000, which makes it more difficult for a private physician
practice to  financially  justify an investment  to provide EECP therapy.  It is
difficult  for us to  determine  the exact  impact  this  decline has had on the
market for EECP therapy. Additionally, the impact from the drop in reimbursement
has been  partially  offset by the  decline in average  selling  prices,  and we
believe  that EECP  therapy  continues  to offer an  attractive  addition to the
physician  private  practice,  plus the  company  has  continued  to support its
customers in gaining  positive  reimbursement  coverage  from other  third-party
payers  during the past year.  EECP  therapy is now  covered by the  majority of
private  insurers for treating  angina  patients,  including many of the leading
Blue Cross Blue Shield plans,  who typically  are the most  difficult  payers to
adopt coverage for new technologies.

Gross Profit

     Gross profit  declined to  $9,591,243 or 64% of revenues for the year ended
May 31, 2005,  compared to $14,616,934 or 66% of revenues for the year ended May
31, 2004.  Gross profit margin as a percentage of revenue for the year ended May
31,  2005,  declined  compared  to the same  period  of the  prior  fiscal  year
reflecting  reduced margins from EECP equipment sales due to the negative impact
resulting  from the reduction in average  selling  prices.  The gross profit for
rentals and services  improved  both in absolute  amount and as a percentage  of
revenue  reflecting  increased  service  resulting  from  accessory  and service
contract revenue increases exceeding  associated cost increases.  The decline in
gross  profit when  compared  to the prior year in absolute  dollars is a direct
result of the lower revenue.

     Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their  respective  average selling prices,  the mix of EECP
units sold,  rented or placed during the period,  the ongoing costs of servicing
such units, and certain fixed period costs,  including  facilities,  payroll and
insurance.  Gross profit margins are generally less on non-domestic business due
to the use of distributors resulting in lower selling prices. Consequently,  the
gross profit  realized during the current period may not be indicative of future
margins.

Selling, General and Administrative

     Selling,  general and administrative  ("SG&A") expenses for the years ended
May  31,  2005  and  May  31,  2004  were  $12,006,774  or 80% of  revenues  and
$12,910,997 or 58% of revenues, respectively,  reflecting a decrease of $904,223
or 7%. The decrease in SG&A  expenditures in fiscal 2005 compared to fiscal 2004
resulted  primarily from a $590,192  decrease in  administrative  consulting and
severance  fees,  $103,637  lower  promotional  allowances,  and $118,002  lower
advertising costs,  partially offset by $150,910 higher market research fees and
$142,193  higher  trade show costs.  On May 5, 2005,  the Company  announced  an
initiative to improve  alignment of  operations  to pursue the CHF market.  This
initiative,  which included a workforce  reduction plus tighter expense control,
is  expected  to provide a clear  focus on CHF  investment  and to reduce  total
expenses by approximately $3,000,000 in fiscal 2006.

Research and Development

     Research and development  ("R&D") expenses of $3,064,683 or 20% of revenues
for the year ended May 31,  2005,  decreased  by $683,706 or 18%,  from the year
ended May 31, 2004,  of  $3,748,389  or 17% of revenues.  The decrease  reflects
lower spending  related to the PEECH clinical trial following  completion of the
clinical treatment portion of the trial in fiscal year 2004, partially offset by
increased  expenditures  for developing  the new  Lumenair(TM)  EECP(R)  Therapy
System, which was launched in November 2004.

Provision for Doubtful Accounts

     During the year ended May 31, 2005, we charged $11,084 to our provision for
doubtful  accounts as compared to $1,296,759 during the year ended May 31, 2004.
The decrease was due primarily to a $680,000  provision made in the prior fiscal
period associated with the write-off of all funds due from a major customer that
ceased operations in December 2003.

                                       29
<PAGE>
Interest Expense and Financing Costs

     Interest  expense and  financing  costs  decreased  to $105,232 in the year
ended May 31, 2005,  from $132,062 for the prior year  reflecting a reduction in
outstanding  debt.  Interest  expense  reflects  interest  on loans  secured  to
refinance the November 2000 purchase of our headquarters and warehouse facility,
as well as on loans  secured to  finance  the cost and  implementation  of a new
management information system.

Interest and Other Income, Net

     Interest  and other  income  for the  fiscal  years of 2005 and  2004,  was
$74,153 and  $99,393,  respectively.  The  decrease in interest and other income
from the prior  year is the direct  result of the  absence  of  interest  income
related to certain  equipment sold under  sales-type  leases  incurred in fiscal
2004 and  lower  miscellaneous  customer  payments,  partially  offset by higher
interest income due to improved yields.

Income Tax Expense, Net

     During the fiscal year ended May 31, 2005 and 2004, we recorded a provision
for state income taxes of $39,661 and 50,640, respectively.  As of May 31, 2005,
we had recorded deferred tax assets of $14,582,000 net of a $3,774,000 valuation
allowance  related to the anticipated  recovery of tax loss  carryforwards.  The
recorded  deferred tax asset and increase to the valuation  allowance during the
year ended May 31, 2005, was $1,866,000.

Liquidity and Capital Resources

Cash and Cash Flow

     We have  financed our  operations in fiscal 2006,  2005 and 2004  primarily
from working capital and in fiscal 2006 from the issuance of preferred stock. At
May 31, 2006, we had cash, cash equivalents, and certificates of deposit balance
of  $2,385,778  and working  capital of  $2,867,288 as compared to cash and cash
equivalents of $2,747,967 and working capital of $3,932,769 at May 31, 2005. Our
cash, cash equivalents,  and certificates of deposit balances decreased $362,189
in fiscal year 2006.  Our net loss of  $10,701,141  was  partially  offset by an
adjustment to reconcile the net loss to net cash and changes in working  capital
accounts of $8,425,268 plus cash provided by financing activities of $1,913,684.

     The  adjustments  to  reconcile  net  loss to net  cash  used in  operating
activities  consisted mainly of $8,008,002 in non-cash  adjustments to reconcile
the not loss to net  used in  operating  activities,  primarily  $7,093,000  for
deferred income taxes,  as well as an aggregate of $915,002 in depreciation  and
amortization,  allowances for doubtful accounts,  inventory reserves plus common
stock and stock  options  issued  for  services.  In  addition,  changes  in our
operating assets and liabilities  produced net cash of $942,057.  The changes in
the accounts  balances  primarily  reflect a decrease in accounts  receivable of
$938,403,  lower inventory of $699,371 and lower other assets of $115,853, which
were partially offset by a decrease in accounts payable and accrued  liabilities
of  $1,070,978  and a decrease in other  liabilities  of $236,501.  Net accounts
receivable were 46% of revenues for the  three-month  period ended May 31, 2006,
as compared to 50% for the  three-month  period ended May 31, 2005, and accounts
receivable turnover improved to 7.9 times as of May 31, 2006, as compared to 4.1
times as of May 31, 2005.

     Standard payment terms on our domestic equipment sales are generally net 30
to 90 days from  shipment and do not contain  "right of return"  provisions.  We
have  historically  offered a  variety  of  extended  payment  terms,  including
sales-type  leases,  in certain  situations and to certain customers in order to
expand the  market for our EECP  products  in the US and  internationally.  Such
extended payment terms were offered in lieu of price concessions, in competitive
situations,  when opening new markets or geographies  and for repeat  customers.
Extended payment terms cover a variety of negotiated terms, including payment in
full - net 120, net 180 days or some fixed or variable  monthly  payment  amount
for a six to twelve month period followed by a balloon  payment,  if applicable.
During the first three  quarters of fiscal 2006 and 2005,  approximately  0% and
3%, respectively, of revenues were generated from sales in which initial payment
terms  were  greater  than 90 days and we offered no  sales-type  leases  during
either  period.  In  general,   reserves  are  calculated  on  a  formula  basis
considering factors such as the aging of the receivables, time past due, and the
customer's  credit history and their current financial status. In most instances
where reserves are required, or accounts are ultimately  written-off,  customers
have  been  unable to  successfully  implement  their  EECP  program.  As we are
creating a new market for the EECP therapy and  recognizing  the challenges that
some customers may encounter, we have opted, at times, on a customer-by-customer
basis, to recover our equipment instead of pursuing other legal remedies,  which
has resulted in our recording of a reserve or a write-off.

                                       30
<PAGE>
     Investing activities provided net cash of $1,758,443 during the fiscal year
ended May 31, 2006. Cash was provided by the sale of short-term  certificates of
deposit.  All of our certificates of deposit had original  maturities of greater
than three months and mature in less than twelve months.

     Our financing  activities provided net cash of $1,913,684 during the fiscal
year ended May 31, 2006, reflecting $2,150,117 in net proceeds received from the
issuance of preferred stock and $302,052 in proceeds for the issuance of a short
note  payable,  less  payments  on our  outstanding  notes  and  loans  totaling
$447,393, and preferred stock dividend payments totaling $91,623.

     We do not have an available line of credit.

Sale of Convertible Preferred Stock and Warrants

     On July 19,  2005,  we entered into a Securities  Purchase  Agreement  that
provided us with gross proceeds of $2.5 million  through a private  placement of
preferred stock with M.A.G.  Capital,  LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the  "Investors").  The  agreement  provided for a private  placement of 25,000
shares  of  Vasomedical's  Series  D  Preferred  Stock at $100  per  share.  The
preferred stock was convertible into shares of Vasomedical's  common stock at 85
percent of the volume weighted average price per share for the five trading days
preceding  any  conversion,  but not at more than $0.6606 or less than $0.40 per
share.  After  registration  in August 2005 the shares of common  stock could be
acquired through conversion of the preferred shares. The Investors also acquired
warrants for the purchase of 1,892,219  shares of common stock. The warrants may
be exercised at a price of $0.69 per share for a term of five years, ending July
18, 2010.

     By  the  placement  of the  preferred  stock  described  above,  we  became
obligated to pay a cash dividend monthly on the outstanding  shares of preferred
stock. The dividend rate was the higher of (i) the prime rate as reported by the
Wall Street  Journal on the first day of the month,  plus three percent or, (ii)
8.5% times $100 per share, but in no event greater than 10% annually.

     During the period  beginning on September 14, 2005, and ending  February 7,
2006, all the preferred  stock issued under this financing were converted into a
total of 6,112,209  shares of common  stock and the are no  remaining  shares of
preferred stock outstanding.

     These  securities  were  offered  and sold to the  Investors  in a  private
placement  transaction  made  in  reliance  upon  exemptions  from  registration
pursuant  to Section  4(2) of the  Securities  Act of 1933.  The  Investors  are
accredited  investors as defined in Rule 501 of Regulation D  promulgated  under
the Securities Act of 1933.  Vasomedical  intends to apply the funds for working
capital.

Liquidity

     We have  incurred  declines  in  revenue  and  have  sustained  significant
operating  losses  during the last three fiscal years and  currently  anticipate
that we will  continue  to sustain  operating  losses.  Our  ability to continue
operating,  as a going  concern is dependent  upon  achieving  profitability  or
through additional debt or equity financing.  Achieving profitability is largely
dependent  on our  ability to reduce  operating  costs  sufficiently  as well as
halting the current  trend of  declining  revenue.  Our ability to maintain  our
current base of revenue is largely  dependent upon  restructuring  our sales and
marketing  efforts  in  the  angina  market  where  reimbursement  is  currently
available  and  operating  in a more  efficient  manner.  If we are not  able to
reverse the trend of declining  revenue and sufficiently  reduce operating costs
to generate an adequate cash flow, or raise additional  capital,  we will not be
able to continue as a going concern.  In this regard,  our independent  auditors
report for fiscal 2006 states that there is substantial  doubt about our ability
to continue as a going concern.

     In  January  2006,  in order to  reduce  the cash  burn and  bring our cost
structure  more into  alignment  with  current  revenue,  we initiated a company
restructuring,  to reduce  personnel and spending on marketing  and  development
projects.  We anticipate that the  restructuring  will reduce  manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition,  in April 2006,  the board of directors  elected to defer meeting fees
and certain senior  executives  elected to defer  approximately  $0.4 million in
annual  salary  compensation.  We believe that these steps to conserve cash will
provide the Company with the opportunity to rebuild sales to a profitable  level
and/or explore strategic opportunities.

     Based on the continuation of current revenue levels and the  implementation
of our restructuring  plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.

     In the event that additional capital is required, we may seek to raise such
capital  through public or private equity or debt  financings or other means. We
may not be able to obtain additional  financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to

                                       31
<PAGE>

further  scale back our  operations,  research,  marketing  or sales  efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish  rights to technologies or products.  Future
capital funding, if available,  may result in dilution to current  shareholders,
and new investors could have rights superior to existing stockholders.

Off-Balance Sheet Arrangements

     As part of our on-going  business,  we do not  participate in  transactions
that  generate   relationships   with   unconsolidated   entities  or  financial
partnerships,  such as  entities  often  referred  to as  structured  finance or
special purpose  entities  (`SPES"),  which would have been  established for the
purpose of facilitating  off-balance sheet  arrangements or other  contractually
narrow or limited  purposes.  As of May 31,  2006,  we are not  involved  in any
unconsolidated SPES.

Contractual Obligations

     The following table presents our expected cash requirements for contractual
obligations outstanding as of May 31, 2006:
<TABLE>
<CAPTION>
                                                                        Due as of       Due as of
                                                       Due as of       5/31/08 and     5/31/10 and          Due
                                      Total             5/31/07          5/31/09         5/31/11        Thereafter
--------------------------------------------------------------------------------------------------------------------
<S>                                    <C>              <C>             <C>            <C>              <C>
Long-Term Debt                         $950,498         $97,309         $136,195       $ 156,739        $560,255
Operating Leases                         14,238          14,238               --              --              --
Employment Agreements                        --              --               --              --              --
--------------------------------------------------------------------------------------------------------------------
Total Contractual Cash
Obligations                            $964,736        $111,547         $136,195        $156,739        $560,255
====================================================================================================================
</TABLE>

     In April 2006,  the  Company  approved a program to defer  compensation  of
certain  senior  executives  of the  company  and  incentives  to them for these
deferrals.  The Company agreed to repay monies  deferred from zero to six months
at 1.5 times the amount deferred;  for deferrals of six months to twelve months,
the repaid amount shall be two times the amount  deferred;  and for deferrals in
excess of twelve months,  the amount shall be 2.5 times the amount deferred.  In
addition, payment of board of directors meeting fees were deferred until a later
date.

Effects of Inflation

     We believe that  inflation  and  changing  prices over the past three years
have  not  had a  significant  impact  on  our  revenue  or on  our  results  of
operations.

Critical Accounting Policies

     Financial  Reporting  Release No. 60, which was released by the  Securities
and Exchange  Commission,  or SEC, in December  2001,  requires all companies to
include a  discussion  of critical  accounting  policies or methods  used in the
preparation  of  financial  statements.  Note B of  the  Notes  to  Consolidated
Financial  Statements  included  in our Annual  Report on Form 10-K for the year
ended May 31, 2006,  includes a summary of our significant  accounting  policies
and methods used in the  preparation of our financial  statements.  In preparing
these  financial  statements,  we have made our best  estimates and judgments of
certain amounts included in the financial  statements,  giving due consideration
to  materiality.  The  application  of these  accounting  policies  involves the
exercise of judgment and use of assumptions as to future uncertainties and, as a
result,  actual  results  could  differ  from  these  estimates.   Our  critical
accounting policies are as follows:

Revenue Recognition

     We recognize  revenue when  persuasive  evidence of an arrangement  exists,
delivery  has  occurred  or  service  has been  rendered,  the price is fixed or
determinable and collectibility is reasonably  assured. In the United States, we
recognize  revenue  from the sale of our EECP  systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies,  accessories and spare
parts  delivered  to both  domestic  and  international  customers.  Returns are
accepted prior to the in-service and training subject to a 10% restocking charge
or for normal warranty matters,  and we are not obligated for post-sale upgrades
to these systems.  In addition,  we use the installment method to record revenue

                                       32
<PAGE>

based on cash receipts in situations  where the account  receivable is collected
over an extended period of time and in our judgment the degree of collectibility
is uncertain.

     In most cases,  revenue from domestic  EECP system sales is generated  from
multiple-element  arrangements  that  require  judgment in the areas of customer
acceptance,  collectibility,  the  separability of units of accounting,  and the
fair value of individual  elements.  Effective September 1, 2003, we adopted the
provisions of Emerging  Issues Task Force,  or EITF,  Issue No. 00-21,  "Revenue
Arrangements  with  Multiple  Deliverables",  ("EITF  00-21"),  on a prospective
basis. The principles and guidance outlined in EITF 00-21 provide a framework to
determine (a) how the arrangement  consideration  should be measured (b) whether
the arrangement should be divided into separate units of accounting, and (c) how
the  arrangement  consideration  should be allocated among the separate units of
accounting.  We determined that the domestic sale of our EECP systems includes a
combination of three elements that qualify as separate units of accounting:

     i.   EECP equipment sale,
     ii.  provision of in-service and training  support  consisting of equipment
          set-up and training provided at the customer's facilities, and
     iii. a service  arrangement  (usually one year),  consisting of: service by
          factory-trained  service  representatives,  material  and labor costs,
          emergency  and  remedial  service  visits,  preventative  maintenance,
          software  upgrades,  technical  phone support and  preferred  response
          times.

     Each of these  elements  represent  individual  units of  accounting as the
delivered  item has value to a customer on a  stand-alone  basis,  objective and
reliable  evidence of fair value exists for undelivered  items, and arrangements
normally do not  contain a general  right of return  relative  to the  delivered
item. We determine fair value based on the price of the  deliverable  when it is
sold  separately  or based  on  third-party  evidence.  In  accordance  with the
guidance in EITF 00-21,  we use the residual  method to allocate the arrangement
consideration  when it does not have fair value of the EECP system  sale.  Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement  consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:

     i.   EECP equipment  sales,  when delivery and  acceptance  occurs based on
          delivery  and  acceptance   documentation  received  from  independent
          shipping companies or customers,
     ii.  in-service  and  training,  following  documented  completion  of  the
          training, and
     iii. the service  arrangement,  ratably over the service  period,  which is
          generally one year.

     In-service and training generally occurs within three weeks of shipment and
our return policy states that no returns will be accepted  after  in-service and
training has been  completed.  The amount  related to in-service and training is
recognized  as  equipment  revenue at the time the  in-service  and  training is
completed and the amount related to service  arrangements is recognized  ratably
over the related service period,  which is generally one year.  Costs associated
with the  provision of  in-service  and  training  and the service  arrangement,
including salaries,  benefits, travel, spare parts and equipment, are recognized
in cost of equipment sales as incurred.

     We also recognize revenue generated from servicing EECP systems that are no
longer covered by the service arrangement, or by providing sites with additional
training,  in the period that these  services are provided.  Revenue  related to
future  commitments under separately  priced extended service  agreements on our
EECP  system are  deferred  and  recognized  ratably  over the  service  period,
generally  ranging  from  one  year to four  years.  Costs  associated  with the
provision of service and  maintenance,  including  salaries,  benefits,  travel,
spare parts and equipment, are recognized in cost of sales as incurred.  Amounts
billed in excess of revenue  recognized are included as deferred  revenue in the
consolidated balance sheets.

     Revenues  from  the  sale  of  EECP  systems   through  our   international
distributor  network are generally  covered by a one-year warranty period. We do
not offer a service arrangement to international  customers;  consequently,  for
these  customers  we accrue a warranty  reserve for  estimated  costs to provide
warranty services when the equipment sale is recognized.

     We have also entered into lease agreements for our EECP systems,  generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized,  in accordance with the terms of
the lease agreements,  on a straight-line  basis over the life of the respective
leases.  For certain operating leases in which payment terms are determined on a
"fee-per-use" basis,  revenues are recognized as incurred (i.e., as actual usage
occurs). The cost of the EECP system utilized under operating leases is recorded
as a component of property and  equipment  and is amortized to cost of equipment
rentals and services over the  estimated  useful life of the  equipment,  not to
exceed five years. There were no significant minimum rental commitments on these
operating leases at May 31, 2006.

                                       33
<PAGE>
Accounts Receivable/Financing Receivables

     Our  accounts  receivable  - trade are due from  customers  engaged  in the
provision  of medical  services.  Credit is extended  based on  evaluation  of a
customer's  financial  condition  and,  generally,  collateral  is not required.
Accounts receivable are generally due 30 to 90 days from shipment and are stated
at amounts due from customers net of allowances for doubtful accounts,  returns,
term  discounts  and other  allowances.  Accounts  outstanding  longer  than the
contractual  payment  terms  are  considered  past  due.  Estimates  are used in
determining  the  allowance  for  doubtful   accounts  based  on  the  Company's
historical  collections   experience,   current  trends,  credit  policy  and  a
percentage of our accounts  receivable by aging category.  In determining  these
percentages,  we look at historical write-offs of our receivables.  We also look
at the  credit  quality  of our  customer  base as well as changes in our credit
policies.  We continuously  monitor collections and payments from our customers.
While  credit  losses  have  historically  been  within   expectations  and  the
provisions established,  we cannot guarantee that we will continue to experience
the same credit loss rates that we have has in the past.

     In addition, we periodically review and assess the net realizability of our
receivables  arising from sales-type  leases.  If this review results in a lower
estimate of the net  realizable  value of the  receivable,  an allowance for the
unrealized amount is established in the period in which the estimate is changed.
In the  second  quarter  of fiscal  2004,  we  decided  to  write-off  financing
receivables under sales-type leases of approximately $680,000,  respectively, as
a result of significant uncertainties with respect to this customer's ability to
meet its financial obligations.

Inventories, net

     We value  inventory  at the lower of cost or estimated  market,  cost being
determined  on a  first-in,  first-out  basis.  We often  place EECP  systems at
various  field  locations for  demonstration,  training,  evaluation,  and other
similar purposes at no charge.  The cost of these EECP systems is transferred to
property  and  equipment  and is amortized  over the next two to five years.  We
record  the  cost  of  refurbished  components  of  EECP  systems  and  critical
components at cost plus the cost of refurbishment. We regularly review inventory
quantities on hand,  particularly  raw materials  and  components,  and record a
provision  for excess and  obsolete  inventory  based  primarily on existing and
anticipated design and engineering  changes to our products as well as forecasts
of future product demand.  Inventory on hand that exceeds two years requirements
based on forecasted demand is considered excess.

     Effective June 1, 2005, we adopted the provisions of Statement of Financial
Accounting  Standards No. 151,  "Inventory  Costs", on a prospective  basis. The
statement  clarifies that abnormal  amounts of idle facility  expense,  freight,
handling  costs,  and  wasted  materials  (spoilage)  should  be  recognized  as
current-period charges and requires the allocation of fixed production overheads
to inventory  based on the normal  capacity of the production  facilities.  As a
result of adopting  SFAS No. 151, we  absorbed  approximately  $256,000  less in
fixed production overheads into inventory during fiscal year 2006.

Deferred Revenues

     We record revenue on extended  service  contracts  ratably over the term of
the related  contracts.  In addition,  we defer  revenue  related to EECP system
sales for the fair value of installation  and in-service  training to the period
when the services are  rendered  and for service  arrangements  ratably over the
service period, which is generally one year.

Warranty Costs

     Equipment sold in domestic  markets is generally  covered by a warranty and
service arrangement period of one year. For certain  arrangements,  a portion of
the overall system price  attributable to the first year service  arrangement is
deferred and  recognized as revenue over the service  period.  As such, we don't
accrue  warranty costs upon delivery but rather  recognize  warranty and related
service costs as incurred.

     Equipment sold to international  customers through our distributor  network
is generally  covered by a one-year  warranty period.  We do not offer a service
arrangement to  international  customers;  consequently,  for these customers we
accrue a warranty reserve for estimated costs to provide warranty  services when
the equipment sale is recognized.

     The factors affecting our warranty  liability  included the number of units
sold and historical  and  anticipated  rates of claims and costs per claim.  The
warranty provision  resulting from transactions prior to September 1, 2003, will
be reduced in future  periods for material  and labor costs  incurred as related
product is  returned  during the  warranty  period or when the  warranty  period
elapses.

Net Loss per Common Share

     Basic  loss per  share is based on the  weighted  average  number of common
shares outstanding without consideration of potential common stock. Diluted loss
per  share is based on the  weighted  number of common  and  potential  dilutive

                                       34
<PAGE>

common shares  outstanding.  The calculation  takes into account the shares that
may be issued upon the exercise of stock  options and  warrants,  reduced by the
shares that may be repurchased with the funds received from the exercise,  based
on the average price during the period

Income Taxes

     Deferred  income taxes are  recognized  for temporary  differences  between
financial  statement  and income tax bases of assets  and  liabilities  and loss
carryforwards  for which  income tax  benefits  are  expected  to be realized in
future years. A valuation  allowance is established,  when necessary,  to reduce
deferred tax assets to the amount expected to be realized.  In estimating future
tax consequences, we generally consider all expected future events other than an
enactment  of  changes  in the tax laws or  rates.  The  deferred  tax  asset is
continually  evaluated for  realizability.  To the extent our judgment regarding
the  realization  of the  deferred  tax assets  changes,  an  adjustment  to the
allowance is recorded,  with an offsetting increase or decrease, as appropriate,
in income tax expense.  Such adjustments are recorded in the period in which our
estimate as to the  realizability  of the asset  changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not"  standard is  subjective,  and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.

     Deferred  tax   liabilities   and  assets  are  classified  as  current  or
non-current  based on the  classification  of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or  liability  for  financial  reporting,  including  deferred  tax assets
related to carryforwards, are classified according to the expected reversal date
of the  temporary  difference.  The  deferred tax asset we  previously  recorded
relates  primarily to the  realization of net operating loss  carryforwards,  of
which the  allocation  of the current  portion,  if any,  reflected the expected
utilization of such net operating  losses in the following  twelve months.  Such
allocation  was based on our internal  financial  forecast and may be subject to
revision based upon actual results.

Stock-based Employee Compensation

     We have five  stock-based  employee and  director  compensation  plans.  We
account  for  stock-based  compensation  using  the  intrinsic  value  method in
accordance  with  Accounting  Principles  Board Opinion No. 25,  "Accounting for
Stock Issued to Employees," and related  Interpretations ("APB No. 25") and have
adopted the disclosure provisions of Statement of Financial Accounting Standards
No. 148,  "Accounting for Stock-Based  Compensation - Transition and Disclosure,
an  amendment  of FASB  Statement  No. 123." Under APB No. 25, when the exercise
price of our employee  stock options  equals the market price of the  underlying
stock on the date of grant, no compensation expense is recognized.  Accordingly,
no  compensation  expense  has been  recognized  in the  consolidated  financial
statements in  connection  with employee  stock option  grants.  For purposes of
estimating  the fair  value of each  option  on the date of grant,  the  Company
utilized  the  Black-Scholes  option-pricing  model.  The  Black-Scholes  option
valuation  model was developed  for use in  estimating  the fair value of traded
options,  which  have no vesting  restrictions  and are fully  transferable.  In
addition,  option  valuation  models  require  the  input of  highly  subjective
assumptions including the expected stock price volatility. Because the Company's
employee stock options have characteristics  significantly  different from those
of traded options and because  changes in the subjective  input  assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.

     Equity  instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.

Recently Issued Accounting Pronouncements Not Yet Effective

     In December 2004, the FASB issued Statement of Financial  Standards No. 123
(revised 2004), Share-Based Payment ("SFAS No. 123 (R)"), which is a revision of
SFAS No. 123. SFAS No. 123 (R)  supersedes  APB Opinion No. 25,  Accounting  for
Stock Issued to Employees,  and amends FASB Statement No. 95,  Statement of Cash
Flows.  Generally,  the approach to accounting for share-based  payments in SFAS
No. 123(R) is similar to the approach  described in SFAS No. 123. However,  SFAS
No. 123(R) requires all share-based  payments to employees,  including grants of
employee stock options,  to be recognized in the financial  statements  based on
their  fair  values.  Pro  forma  disclosure  of the fair  value of  share-based
payments is no longer an alternative to financial  statement  recognition.  SFAS
No.  123(R) is effective for small public  business  issuers at the beginning of
the first fiscal year beginning after December 15, 2005, and therefore effective
for the Company with the fiscal quarter ending August 31, 2006.

         In May 2006, the compensation committee of the board of directors
accelerated the vesting provision of all outstanding stock options and warrants
so that they were fully vested at May 31, 2006, as a result the Company expects
the adoption of SFAS No. 123(R) to not to have an immediate material effect on

                                       35
<PAGE>

its financial statements, however as new on a stock options are issued the
Company does anticipate the adoption of SFAS No 123(R) will have a material
effect on its quarterly and annual financial statements, in the form of
additional compensation expense. It is not possible to precisely determine the
expense impact of adoption since a portion of the ultimate expense that is
recorded will likely relate to awards that have not yet been granted. The
expense associated with these future awards can only be determined based on
factors such as the price for the Company's common stock, volatility of the
Company's stock price and risk free interest rates as measured at the grant
date. However, the pro forma disclosures related to SFAS No. 123 included in the
Company's historic financial statements are relevant data points for gauging the
potential level of expense that might be recorded in future periods.

     Statement of Financial  Accounting  Standards No. 152, "Accounting for Real
Estate Time-Sharing Transactions",  an amendment of FASB Statements no 66 and 67
(SFAS 152) was issued in  December  2004 and  becomes  effective  for  financial
statements for fiscal years  beginning after June 15, 2005. The Company does not
expect that SFAS 152 will have an effect on future financial statements.

     In December  2004, the FASB issued FASB Statement No. 153 ("SFAS No. 153"),
"Exchanges  of  Non-monetary  Assets - an amendment of APB Opinion No. 29". SFAS
No. 153 amends Opinion 29 to eliminate the exception for non-monetary  exchanges
of  similar  productive  assets and  replaces  it with a general  exception  for
exchanges  of  non-monetary  assets  that do not have  commercial  substance.  A
non-monetary  exchange has commercial  substance if the future cash flows of the
entity are expected to change  significantly  as a result of the exchange.  SFAS
No. 153 is effective for fiscal  periods  after June 15, 2005.  The Company does
not  expect  the  adoption  of SFAS No.  153 to have a  material  impact  on the
Company's consolidated financial statements.

     In May 2005, the FASB issued  Statement of Financial  Accounting  Standards
No. 154 ("SFAS No. 154"),  "Accounting  Changes and Error Corrections." SFAS No.
154 replaces APB Opinion No. 20, Accounting  Changes,  and FASB Statement No. 3,
Reporting  Accounting Changes in Interim Financial  Statements,  and changes the
requirements  for the  accounting  for and  reporting of a change in  accounting
principle.  The  Statement  applies  to  all  voluntary  changes  in  accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. When a pronouncement includes specific transition provisions,  those
provisions should be followed.  SFAS No. 154 is effective for accounting changes
and  corrections  of errors made in fiscal years  beginning  after  December 15,
2005.

     Statement of Financial Accounting Standards No. 155, Accounting for Certain
Hybrid Financial  Instruments--an  amendment of FASB Statements No. 133 and 140,
was issued in  February  2006 and is  effective  for all  financial  instruments
acquired or issued  after the  beginning  of an entity's  first fiscal year that
begins after September 15, 2006.  Certain parts of this Statement may be applied
prior to the adoption of this Statement. Earlier adoption is permitted as of the
beginning  of an entity's  fiscal  year,  provided the entity has not yet issued
financial statements,  including financial statements for any interim period for
that fiscal year.  Provisions of this  Statement  may be applied to  instruments
that an  entity  holds at the date of  adoption  on an  instrument-by-instrument
basis.  The  Company  does not  expect  that SFAS 155 will have any  significant
effect on future financial statements.

     Statement  of  Financial  Accounting  Standards  No.  156,  Accounting  for
Servicing of Financial  Assets--an amendment of FASB Statement No. 140, pertains
to the servicing of financial  assets and was issued in March 2006 and should be
adopted as of the beginning of its first fiscal year that begins after September
15,  2006.  Earlier  adoption is  permitted  as of the  beginning of an entity's
fiscal  year,  provided  the  entity has not yet  issued  financial  statements,
including interim financial statements,  for any period of that fiscal year. The
Company does not expect that SFAS 156 will have any significant effect on future
financial statements.

     In March 2005, FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement  Obligations--an  interpretation  of FASB Statement No. 143 (FIN 47).
FIN 47 is effective no later than the end of fiscal years ending after  December
15, 2005  (December  31, 2005,  for  calendar-year  enterprises).  Retrospective
application for interim financial  information is permitted but is not required.
Early adoption of this Interpretation is encouraged. The Company does not expect
that FIN 47 will have any significant effect on future financial statements.

     In December  2004,  the  Accounting  Standards  Executive  Committee of the
American Institute of Certified Public  Accountants  (AcSEC) issued Statement of
Position 04-2, Accounting for Real Estate Time-Sharing  Transactions (SOP 04-2).
SOP 04-2 is effective for financial statements issued for fiscal years beginning
after June 15, 2005, with earlier application  encouraged.  The Company does not
expect that SOP 04-2 will have any effect on future financial statements.

     In September 2005, AcSEC issued  Statement of Position 05-1:  Accounting by
Insurance   Enterprises  for  Deferred  Acquisition  Costs  in  Connection  with
Modifications  or  Exchanges  of  Insurance  Contracts  (SOP 05-1).  SOP 05-1 is
effective  for fiscal years  beginning  after  December  15, 2006,  with earlier
adoption  encouraged.  The  Company  does not expect that SOP 05-1 will have any
effect on future financial statements.

                                       36
<PAGE>
     FASB Staff  Position (FSP) FAS  13-1--Accounting  for Rental Costs Incurred
during a  Construction  Period,  was  issued on October  6,  2005,  and  becomes
effective for the for new  transactions or  arrangements  entered into after the
beginning of the first fiscal  quarter  following the date that the final FSP is
posted by the FASB.  The  Company  does not  expect  that FSP 13-1 will have any
significant effect on future financial statements.

     On June 29,  2005,  the FASB  ratified the  consensus  reached for Emerging
Issues Task Force (EITF)  Issue No. 05-5,  Accounting  for Early  Retirement  or
Postemployment  Programs  with  Specific  Features  (Such As Terms  Specified in
Altersteilzeit  Early  Retirement  Arrangements).  The  consensus  in this Issue
should be applied  to fiscal  years  beginning  after  December  15,  2005,  and
reported as a change in accounting  estimate  effected by a change in accounting
principle as described in paragraph 19 of FASB  Statement  154. The Company does
not expect that EITF 05-5 will have any significant  effect on future  financial
statements.

     On September 28, 2005,  the FASB  ratified the  consensus  reached for EITF
Issue No. 05-7,  Accounting for Modifications to Conversion  Options Embedded in
Debt  Instruments  and Related  Issues.  The  provisions of this Issue should be
applied  to future  modifications  of debt  instruments  beginning  in the first
interim or annual  reporting  period  beginning  after  December 15,  2005.  The
Company  expects  that the  application  of EITF  05-7  could  have an effect on
interest and debt valuations in future financial statements.  It is not possible
to determine the impact, if any, from the application since the Company does not
presently have any convertible debt.

     On September 28, 2005,  the FASB  ratified the  consensus  reached for EITF
Issue No.  05-8,  Income Tax  Consequences  of Issuing  Convertible  Debt with a
Beneficial  Conversion  Feature.  The provisions of this Issue should be applied
beginning  in the first  interim  or annual  reporting  period  beginning  after
December 15, 2005. The Company  expects that the  application of EITF 05-8 could
have an effect on he income tax expense reported in future financial statements.
It is not possible to determine the impact,  if any, from the application  since
the Company does not presently have any convertible debt.

     On July 13, 2006, the FASB issued  Interpretation No. 48 for Uncertainty in
Income  Taxes  and  interpretation  of FASB  Statement  109.  Interpretation  48
clarifies  the  accounting  for  uncertainty  in income  taxes  recognized  in a
company's  financial  statements  in  accordance  with  Statement  No.  109  and
prescribes a  recognition  threshold  and  measurement  attribute  for financial
statements  disclosure  of tax  position  taken or expected to be taken on a tax
return.  Additionally,  Interpretation No. 48 provides guidance on depreciation,
classification, interest and penalties accounting in interim periods, disclosure
and  transition.  Interpretation  No. 48 is effective for fiscal years beginning
after December 15, 2006, with early adoption permitted. The Company is currently
evaluating  whether the adoption of  Interpretation  No. 48 will have a material
effect on our consolidated  financial  position,  results of operations and cash
flows.

     In July 2006,  the FASB issued  Staff  Position  ("FSB") on FAS 13, FSP FAS
13-2,  Accounting  for a Change or Projected  Change in the Timing of Cash Flows
Relating to Income Taxes  Generated by a Leveraged  Lease  transaction.  FSP FAS
13-2  addresses  how a change or  projected  change in the  timing of cash flows
relating to income taxes generated by a leveraged lease transaction  affects the
accounting by a lessor for that lease and amends FAS 13  Accounting  for Leases.
FSP FAS 13-2 is effective  for fiscal years  beginning  December 15, 2006,  with
earlier  application  permitted.  The Company  does not expect that FSP FAS 13-2
will have any significant effect on future financial statements.

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We are exposed to certain  financial  market  risks,  including  changes in
interest rates. All of the Company's revenue,  expenses and capital spending are
transacted  in US dollars.  Our  exposure to market risk for changes in interest
rates relates primarily to our cash and cash equivalent balances, investments in
sales-type  leases  and the  line  of  credit  agreement.  The  majority  of our
investments  are in short-term  instruments  and subject to  fluctuations  in US
interest rates. Due to the nature of our short-term investments, we believe that
there is no material risk exposure.

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The consolidated  financial  statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this report.

ITEM 9 -  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
          FINANCIAL DISCLOSURE

          None.

                                       37
<PAGE>

 ITEM 9A - CONTROLS AND PROCEDURES

     The Company  carried out an evaluation,  under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial  Officer,  of the  effectiveness  of the design and  operation  of the
Company's  disclosure  controls  and  procedures  pursuant to Exchange  Act Rule
13a-15.  Based  upon that  evaluation,  the Chief  Executive  Officer  and Chief
Financial  Officer  concluded  that as of the end of the period  covered by this
report our  disclosure  controls  and  procedures  are  effective to ensure that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded,  processed,  summarized  and reported  within the time
periods specified in the SEC's rules and forms, and are also effective to ensure
that  information  required to be  disclosed  in our reports  filed or submitted
under  the  Exchange  Act is  accumulated  and  communicated  to  the  Company's
management,  including the principal executive and principal financial officers,
to allow  timely  decisions  regarding  required  disclosure.  During the fourth
fiscal quarter,  there has been no change in our internal control over financial
reporting that has materially  affected,  or is reasonably  likely to materially
affect, our internal control over financial reporting.

ITEM 9B - OTHER INFORMATION.

          None

                                       38

<PAGE>


                                    PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The  information  required by this Item will be included in our  definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2006 Annual Meeting of Stockholders,  and is incorporated
herein by reference.

ITEM 11 - EXECUTIVE COMPENSATION

     The  information  required  by this Item is  intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection  with our 2006 Annual Meeting of  Stockholders,  and is
incorporated herein by reference.

ITEM 12 - SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT AND
          RELATED STOCKHOLDER MATTERS

     The  information  required  by this Item is  intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection  with our 2006 Annual Meeting of  Stockholders,  and is
incorporated herein by reference.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The  information  required  by this Item is  intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection  with our 2006 Annual Meeting of  Stockholders,  and is
incorporated herein by reference.

ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES

     The  information  required  by this Item is  intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection  with our 2006 Annual Meeting of  Stockholders,  and is
incorporated herein by reference.

                                       39
<PAGE>
                                     PART IV

ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


(a)  Financial  Statements  and Financial  Statement  Schedules
     ----------------------------------------------------------
     (1)  See  Index  to  Consolidated  Financial  Statements  on  page  F-1  at
          beginning of attached financial statements.
     (2)  The following Consolidated Financial Statement Schedule is included in
          Part IV of this report:
          Schedule II - Valuation and  Qualifying  Accounts All other  schedules
     are omitted  because they are not applicable,  or not required,  or because
     the  required  information  is  included  in  the  Consolidated   Financial
     Statements or notes thereto.

(b)  Exhibits
     --------

     (3)  (a) Restated Certificate of Incorporation (2)
          (b)  By-Laws (1)
     (4)  (a) Specimen Certificate for Common Stock (1)
          (b)  Certificate of Designation of the Preferred Stock, Series A (3)
          (c)  Certificate of Designation of the Preferred Stock, Series B (7)
          (d)  Form of  Rights  Agreement  dated as of March  9,  1995,  between
               Registrant and American Stock Transfer & Trust Company (5)
          (e)  Certificate of Designation of the Preferred  Stock,  Series C (8)
          (f)  Certificate of Designation of the Preferred Stock, Series D (18)
          (g)  Form of Stock Purchase Warrant (18)

     (10) (a) 1995 Stock Option Plan (6)
          (b)  Outside Director Stock Option Plan (6)
          (c)  Employment Agreement dated February 1, 1995, as amended March 12,
               1998, and October 10, 2001,  between Registrant and John C.K. Hui
               (4) (9) (13)
          (d)  1997 Stock Option Plan, as amended (10)
          (e)  1999 Stock Option Plan, as amended (11)
          (f)  Credit  Agreement dated February 21, 2002,  between  Vasomedical,
               Inc. and Fleet National Bank (12)
          (g)  Agreement dated October 1, 2002, between the Registrant and Peter
               F. Cohn (14)
          (h)  Amendment and Waiver to Credit  Agreement dated October 18, 2002,
               between the Vasomedical, Inc. and Fleet National Bank (14)
          (i)  Amendment  No. 2 and Waiver to Credit  Agreement  dated April 10,
               2003, between the Registrant and Fleet National Bank (15)
          (j)  Employment  Agreement dated September 8, 2003, between Registrant
               and Thomas W. Fry (17)
          (k)  Subscription  Agreement dated July 19, 2005, between Vasomedical,
               Inc. and M.A.G.  Capital LLC, Monarch Pointe Fund Ltd.,  Mercator
               Momentum  Fund  III,  LP and  Mercator  Momentum  Fund,  LP  (the
               "Investors") (18)
          (l)  Registration  Rights  Agreement,  dated  July 19,  2005,  between
               Vasomedical, Inc. and the Investors (18)
          (m)  Form  of  Employment   Agreement  dated  June  22,  2006  between
               Registrant and Thomas Glover.
     (21)      Subsidiaries of the Registrant
<TABLE>
<CAPTION>
                                                                               Percentage
               Name                      State of Incorporation             Owned by Company
               ----                      ----------------------             ----------------
               <S>                               <C>                            <C>
               Viromedics, Inc.                  Delaware                        61%
               180 Linden Avenue Corp.           New York                       100%
</TABLE>
     (23.1)    Consent of Miller Ellin & Company, LLP
     (23.2)    Consent of Grant Thornton LLP
     (31)      Certification  Reports pursuant to  Securities  Exchange Act Rule
               13a - 14
     (32)      Certification  Reports  pursuant to Section 906 of the  Sarbanes-
               Oxley Act of 2002
--------------------------
     (1)  Incorporated by reference to Registration  Statement on Form S-18, No.
          33-24095.
     (2)  Incorporated by reference to  Registration  Statement on Form S-1, No.
          33-46377 (effective 7/12/94).
     (3)  Incorporated  by  reference  to Report on Form 8-K dated  November 14,
          1994.
     (4)  Incorporated  by  reference  to Report on Form 8-K dated  January  24,
          1995.
     (5)  Incorporated by reference to Registration  Statement on Form 8-A dated
          May 12, 1995.
                                       40
<PAGE>
     (6)  Incorporated  by reference to Notice of Annual Meeting of Stockholders
          dated December 5, 1995.
     (7)  Incorporated by reference to Report on Form 8-K dated June 25, 1997.
     (8)  Incorporated by reference to Report on Form 8-K dated April 30, 1998.
     (9)  Incorporated  by  reference to Report on Form 10-K for the fiscal year
          ended May 31, 1998.
     (10) Incorporated  by  reference to Report on Form 10-K for the fiscal year
          ended May 31, 1999
     (11) Incorporated  by  reference to Report on Form 10-K for the fiscal year
          ended May 31, 2000.
     (12) Incorporated  by  reference  to Report on Form 10-Q for the  quarterly
          period ended February 28, 2002.
     (13) Incorporated  by  reference to Report on Form 10-K for the fiscal year
          ended May 31, 2002.
     (14) Incorporated  by  reference  to Report on Form 10-Q for the  quarterly
          period ended November 30, 2002.
     (15) Incorporated  by  reference  to Report on Form 10-Q for the  quarterly
          period ended February 28, 2003.
     (16) Incorporated  by  reference  to Report on Form 10-Q for the  quarterly
          period ended February 29, 2004.
     (17) Incorporated by reference to Report on Form 8-K dated July 19, 2005.

                                       41







<PAGE>

SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934, we have duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the 28th day of August, 2006.

                                 VASOMEDICAL, INC.

                                 By: /s/ Thomas Glover
                                 -----------------------------------------------
                                 Thomas Glover
                                 President, Chief Executive Officer and Director
                                 (Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been  signed  below on August  24,  2006,  by the  following  persons in the
capacities indicated:


/s/ Thomas Glover       President, Chief Executive Officer and Director
Thomas Glover           (Principal Executive Officer)

/s/ Abraham E. Cohen    Chairman of the Board
Abraham E. Cohen

/s/ Thomas W. Fry       Chief Financial Officer (Principal Financial and
Thomas W. Fry           Accounting Officer)

/s/ John C.K. Hui       Senior Vice President, Chief Technology Officer and
John C.K. Hui           Director

/s/ Photios T. Paulson  Director
Photios T. Paulson

/s/ Kenneth W. Rind     Director
Kenneth W. Rind

/s/ Martin Zeiger       Director
Martin Zeiger


                                       42







<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
                                                                                        Page
                                                                                        ----
<S>                                                                                     <C>
Reports of Independent Registered Public Accounting Firms                               F-1 to F-2

Financial Statements
         Consolidated Balance Sheets as of May 31, 2006 and 2005                        F-3

         Consolidated Statements of Operations for the
           years ended May 31, 2006, 2005 and 2004                                      F-4

         Consolidated Statement of Changes in Stockholders'
           Equity for the years ended May 31, 2006, 2005 and 2004                       F-5

         Consolidated Statements of Cash Flows for the
           years ended May 31, 2006, 2005 and 2004                                      F-6 to F-7

         Notes to Consolidated Financial Statements                                     F-8 to F-27

Financial Statement Schedule
         Schedule II - Valuation and Qualifying Accounts                                S-1
</TABLE>

                                       i

<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors and Shareholders
  Vasomedical, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheet of Vasomedical, Inc.
and  Subsidiaries   (the  "Company")  as  of  May  31,  2006,  and  the  related
consolidated statement of operations, stockholders' equity and cash flow for the
period ended May 31, 2006. These financial  statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial   statements  based  on  our  audit.   The  Financial   Statements  of
Vasomedical,  Inc. and Subsidiaries as of May 31, 2005 and 2004, were audited by
other  auditors  whose  report dated July 29,  2005,  expressed  an  unqualified
opinion.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements  are free of material  misstatement.  The Company is not  required to
have,  nor were we  engaged to perform  an audit of its  internal  control  over
financial reporting.  Our audit included  consideration of internal control over
financial  reporting  as  a  basis  for  designing  audit  procedures  that  are
appropriate  in the  circumstances,  but not for the  purpose of  expressing  an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting.  Accordingly,  we express  no such  opinion.  An audit also  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial   statements,   assessing  the  accounting  principles  used  and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audit  provides  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Vasomedical,  Inc.  and  Subsidiaries  as of May 31,  2006 and the  consolidated
results of their operations and their  consolidated cash flow for the year ended
May 31, 2006 in conformity with accounting  principles generally accepted in the
United States of America.

Our audit was  conducted  for the  purpose  of  forming  an opinion on the basic
financial  statements  taken  as a  whole.  The  financial  statement  schedule,
Schedule II, Valuation and Qualifying Accounts, is presented for the purposes of
additional  analysis  and  is  not  a  required  part  of  the  basic  financial
statements.  This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial  statements  and, in our opinion,  is fairly
stated in all material  respects in relation to the basic  financial  statements
taken as a whole.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note A to the
financial statements,  the Company has suffered recurring losses from operations
and a net capital  deficiency that raise  substantial doubt about its ability to
continue as a going concern.  Management's  plans in regard to these matters are
also  described  in  Note  A.  The  financial  statements  do  not  include  any
adjustments that might result from the outcome of this uncertainty.



/s/ Miller Ellin & Company, LLP
MILLER ELLIN & COMPANY, LLP


New York, New York
August 5, 2006

                                      F - 1

<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors and Shareholders
     Vasomedical, Inc. and Subsidiaries

     We have audited the accompanying consolidated balance sheet of Vasomedical,
Inc.  and  Subsidiaries  (the  "Company")  as of May 31,  2005,  and the related
consolidated  statements of operations,  stockholders' equity and cash flows for
each of the  two  years  in the  period  ended  May 31,  2005.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

     We  conducted  our audits in  accordance  with the  standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain  reasonable  assurance about whether the
financial  statements  are free of  material  misstatement.  The  Company is not
required  to have,  nor were we  engaged  to  perform  an audit of its  internal
control over financial reporting.  Our audit included  consideration of internal
control over financial  reporting as a basis for designing audit procedures that
are appropriate in the  circumstances,  but not for the purpose of expressing an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting.  Accordingly,  we express  no such  opinion.  An audit also  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial   statements,   assessing  the  accounting  principles  used  and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly, in all material respects, the consolidated financial position of
Vasomedical,  Inc. and  Subsidiaries  as of May 31, 2005,  and the  consolidated
results of their  operations and their  consolidated  cash flows for each of the
two  years in the  period  ended  May 31,  2005 in  conformity  with  accounting
principles generally accepted in the United States of America.

     As  described  in  Note A to the  consolidated  financial  statements,  the
Company  adopted the  provisions  of the Emerging  Issues Task Force,  Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables", on September 1, 2003.

     Our audit was  conducted for the purpose of forming an opinion on the basic
financial  statements  taken  as a  whole.  The  financial  statement  schedule,
Schedule II, Valuation and Qualifying Accounts, is presented for the purposes of
additional  analysis  and  is  not  a  required  part  of  the  basic  financial
statements.  This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial  statements  and, in our opinion,  is fairly
stated in all material  respects in relation to the basic  financial  statements
taken as a whole.



/s/ GRANT THORNTON LLP

Melville, New York
July 29, 2005

                                      F - 2

<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                                             May 31,
                                                                                    2006                 2005
                                                                              -----------------    -----------------
<S>                                                                               <C>                <C>
                                 ASSETS
CURRENT ASSETS
     Cash and cash equivalents                                                    $2,385,778             $989,524
     Certificates of deposit                                                              --            1,758,443
     Accounts receivable, net of an allowance for doubtful accounts of
       $410,691 and $394,692 at May 31, 2006 and 2005, respectively                  843,282            1,892,002
     Inventories, net                                                              2,699,673            3,360,272
     Other current assets                                                            108,049              223,902
                                                                              -----------------    -----------------
         Total current assets                                                      6,036,782            8,224,143

PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,613,180
   and $2,626,983 at May 31, 2006 and 2005, respectively                           1,569,588            2,234,153
DEFERRED INCOME TAXES                                                                     --           14,582,000
OTHER ASSETS                                                                         305,670              321,174
                                                                              -----------------    -----------------
                                                                                  $7,912,040          $25,361,470
                                                                              =================    =================


                  LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
     Accounts payable and accrued expenses                                          $938,095           $1,569,131
     Current maturities of long-term debt and notes payable                           97,309              148,212
     Sales tax payable                                                               172,646              216,753
     Deferred revenue                                                              1,600,887            1,667,080
     Accrued director fees and executive compensation                                175,000                   --
     Accrued warranty and customer support expenses                                   30,500              110,583
     Accrued professional fees                                                        61,875              401,511
     Accrued commissions                                                              93,182              178,104
                                                                              -----------------    -----------------
         Total current liabilities                                                 3,169,494            4,291,374

LONG-TERM DEBT                                                                       853,189              947,597
ACCRUED WARRANTY COSTS                                                                 1,500                7,750
DEFERRED REVENUE                                                                     721,701              884,452
OTHER LONG-TERM LIABILITIES                                                               --               67,500

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
     Preferred stock, $.01 par value; 1,000,000 shares authorized; none
       issued and outstanding                                                             --                   --
     Common stock, $.001 par value; 110,000,000 shares authorized;
       65,198,592 and 58,552,688 shares at May 31, 2006 and 2005,
       respectively, issued and outstanding                                           65,198               58,552
     Additional paid-in capital                                                   46,148,493           51,450,639
     Accumulated deficit                                                         (43,047,535)         (32,346,394)
                                                                              -----------------    -----------------
         Total stockholders' equity                                                3,166,156           19,162,797
                                                                              -----------------    -----------------
                                                                                  $7,912,040          $25,361,470
                                                                              =================    =================
</TABLE>
   The accompanying notes are an integral part of these financial statements.

                                     F - 3
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                                  Year Ended May 31,
                                                                   -------------------------------------------------
                                                                       2006             2005              2004
                                                                   --------------    -------------     -------------
<S>                                                                  <C>              <C>               <C>
Revenues
   Equipment sales                                                   $6,820,980       $11,516,883       $19,302,593
   Equipment rentals and services                                     4,122,017         3,578,895         2,904,444
                                                                   --------------    -------------     -------------
     Total revenues                                                  10,942,997        15,095,778        22,207,037

Cost of Sales and Services
   Cost of sales, equipment                                           3,374,194         4,223,523         6,309,119
   Cost of equipment rentals and services                             1,400,135         1,281,012         1,280,984
                                                                   --------------    -------------     -------------
     Total cost of sales and services                                 4,774,329         5,504,535         7,590,103
                                                                   --------------    -------------     -------------
   Gross profit                                                       6,168,668         9,591,243        14,616,934

Operating Expenses
   Selling, general and administrative                                7,865,533        12,006,774        12,910,997
   Research and development                                           1,805,667         3,064,683         3,748,389
   Provision for doubtful accounts                                      110,317            11,084         1,296,759
                                                                   --------------    -------------     -------------
     Total operating expenses                                         9,781,517        15,082,541        17,956,145
                                                                   --------------    -------------     -------------
LOSS FROM OPERATIONS                                                 (3,612,849)       (5,491,298)       (3,339,211)

Other Income (Expenses)
   Interest and financing costs                                         (81,662)         (105,232)         (132,062)
   Interest and other income, net                                        75,508            74,153            99,393
                                                                   --------------    -------------     -------------
     Total other income (expenses)                                       (6,154)          (31,079)          (32,669)
                                                                   --------------    -------------     -------------

LOSS BEFORE INCOME TAXES                                             (3,619,003)       (5,522,377)       (3,371,880)
   Income tax expense, net                                           (7,082,138)          (39,661)          (50,640)
                                                                   --------------    -------------     -------------
NET LOSS                                                            (10,701,141)       (5,562,038)       (3,422,520)
   Preferred stock dividend                                            (877,870)               --                --
                                                                   --------------    -------------     -------------
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS                       $(11,579,011)      $(5,562,038)      $(3,422,520)
                                                                   ==============    =============     =============


Net loss per common share
     - basic                                                            $(0.19)           $(0.10)           $(0.06)
                                                                   ==============    =============     =============
     - diluted                                                          $(0.19)           $(0.10)           $(0.06)
                                                                   ==============    =============     =============

Weighted average common shares outstanding
     - basic                                                         61,351,323        58,547,574        57,981,963
                                                                   ==============    =============     =============
     - diluted                                                       61,351,323        58,547,574        57,981,963
                                                                   ==============    =============     =============
</TABLE>
   The accompanying notes are an integral part of these financial statements.

                                     F - 4
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

            CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                                           Additional                     Total
                                         Preferred Stock            Common Stock            Paid-in-   Accumulated    Stockholders'
                                      Share        Amount        Shares        Amount       Capital       Deficit        Equity
                                    ---------- --------------- ----------- -------------- ------------ -------------  ------------
<S>                                     <C>               <C>   <C>               <C>      <C>         <C>              <C>
Balance at May 31, 2003                     --              --  57,822,023        $57,822  $50,623,316  $(23,361,836)  $27,319,302

   Exercise of options and warrants                                597,333            597      696,790                     697,387
   Net loss                                                                                               (3,422,520)   (3,422,520)
                                    ---------- --------------- ----------- -------------- ------------ -------------  ------------
Balance at May 31, 2004                     --              --  58,419,356         58,419   51,320,106   (26,784,356)   24,594,169

   Exercise of options and warrants                                133,332            133      130,533                     130,666
   Net loss                                                                                               (5,562,038)   (5,562,038)
                                    ---------- --------------- ----------- -------------- ------------ -------------  ------------
Balance at May 31, 2005                     --              --  58,552,688        $58,552   51,450,639   (32,346,394)   19,162,797

   Issuance of Series D convertible
     preferred stock, net of costs      25,000            $250                               1,613,209                   1,613,459
  Warrants issued in connection
     with the issuance of Series D
     convertible preferred stock
     issued                                                                                    411,158                     411,158
  Beneficial conversion feature
     embedded in Series D convertible
     preferred stock                                                                           786,247                     786,247
  Dividends of Series D convertible
     preferred stock                                                                          (877,870)                   (877,870)
  Issuance of common stock in
     connection with the conversion
     of Series D convertible
     preferred stock                   (25,000)           (250)  6,112,209          6,112       (5,862)                         --
  Issuance of common stock in
     payment of outside director
     fees                                                          225,000            225      101,025                     101,250
  Issuance of common stock in
     payment of a consulting fee                                   308,695            309      150,691                     151,000
  Issuance of stock options in
     payment of a consulting fee                                                                 8,256                       8,256
  Reserve for tax benefit of
     stock options and warrants
     exercised in prior years                                                               (7,489,000)                 (7,489,000)
  Net loss                                                                                               (10,701,141)  (10,701,141)
                                    ---------- --------------- ----------- -------------- ------------ -------------  ------------
Balance at May 31, 2006                     --              --  65,198,592        $65,198  $46,148,493  $(43,047,535)   $3,166,156
                                    ========== =============== =========== ============== ============ =============  ============
</TABLE>

    The accompanying notes are an integral part of this financial statement.

                                      F - 5
<PAGE>

                       Vasomedical, Inc. and Subsidiaries

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                                  Year ended May 31,
                                                                   -------------------------------------------------
                                                                       2006              2005              2004
                                                                   --------------    -------------     -------------
<S>                                                                <C>               <C>               <C>
Cash flows from operating activities
     Net loss                                                      $(10,701,141)     $(5,562,038)      $(3,422,520)
                                                                   --------------    -------------     -------------
     Adjustments to reconcile net loss to net cash
       provided by (used in) operating activities
         Depreciation and amortization                                 518,176           578,530           749,111
         Provision for doubtful accounts, net of write-offs            110,317            11,084           616,759
         Reserve for excess and obsolete inventory                     152,004           166,672           119,000
         Deferred income taxes                                       7,093,000                --                --
         Common stock issued for services                              126,250                --                --
         Stock options granted for services                              8,256                --                --
         Changes in operating assets and liabilities
              Accounts receivable                                      938,403         3,618,767         1,923,284
              Financing receivables, net                                    --                --           258,608
              Inventories                                              699,371        (1,295,294)        1,187,761
              Other current assets                                     115,853            48,611            (4,282)
              Other assets                                             (28,883)          (63,649)          (69,610)
              Accounts payable, accrued expenses and other
                current liabilities                                 (1,070,978)       (1,662,193)          517,056
              Other liabilities                                       (236,501)         (435,074)          (38,907)
                                                                   --------------    -------------     -------------
                                                                     8,425,268           967,454         5,258,780
                                                                   --------------    -------------     -------------
     Net cash provided by (used in) operating activities            (2,275,873)       (4,594,584)        1,836,260
                                                                   --------------    -------------     -------------

     Cash flows provided by (used in) investing activities
         Purchase of certificates of deposit and treasury                   --        (3,747,903)       (1,180,540)
            bills
         Redemptions of certificates and deposit and                 1,758,443         3,170,000                --
           treasury bills
         Purchase of property and equipment                                 --          (200,198)         (153,954)
                                                                   --------------    -------------     -------------
     Net cash provided by  (used in) investing activities            1,758,443          (778,101)       (1,334,494)
                                                                   --------------    -------------     -------------

     Cash flows provided by (used in) financing activities
         Payments on long term debt and notes payable                 (447,363)         (133,506)         (124,100)
         Payments on preferred stock dividends                         (91,623)               --                --
         Payments on preferred stock issue costs                      (349,382)               --                --
         Proceeds from notes payable                                   302,052                --            67,149
         Proceeds from exercise of options and warrants                     --           130,666           697,387
         Proceeds from sale of convertible preferred stock           2,500,000                --                --
                                                                   --------------    -------------     -------------
     Net cash provided by (used in) financing activities             1,913,684            (2,840)          640,436
                                                                   --------------    -------------     -------------

NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS                                                          1,396,254        (5,375,525)        1,142,202
                                                                   --------------    -------------     -------------
     Cash and cash equivalents - beginning of year                     989,524         6,365,049         5,222,847
                                                                   --------------    -------------     -------------
     Cash and cash equivalents - end of year                        $2,385,778       $   989,524        $6,365,049
                                                                   ==============    =============     =============
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                      F - 6
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
<TABLE>
<CAPTION>
                                                                                   Year ended May 31,
                                                                   -------------------------------------------------
                                                                        2006              2005              2004
                                                                   --------------    -------------     -------------
<S>                                                                   <C>               <C>               <C>
NON-CASH INVESTING AND FINANCING ACTIVITIES WERE AS FOLLOWS:
   Inventories   transferred   from  property  and  equipment,
       attributable to operating leases - net                         $190,776          $142,098          $240,942
     Issue of note for purchase of insurance policy                   $302,052                --                --
     Preferred stock dividends                                        $786,247                --                --
     Preferred issue costs                                            $227,087                --                --

 SUPPLEMENT DISCLOSURES:
     Interest paid                                                     $81,662          $105,232          $105,194
     Income taxes paid                                                 $22,923           $19,888           $24,213
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                     F - 7
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004



NOTE A - ORGANIZATION AND PLAN OF OPERATIONS


     The Company was incorporated in Delaware in July 1987.  During fiscal 1996,
the   Company   commenced   the   commercialization   of   its   EECP   external
counterpulsation system ("EECP"), a microprocessor-based  medical device for the
noninvasive,  outpatient treatment of patients with cardiovascular disease. EECP
is marketed worldwide to hospitals and physician private practices. To date, the
Company's  revenues have been  generated  primarily from customers in the United
States.

     The  Company  has  incurred  large  declines  in  revenue  and  significant
operating  losses during the last three fiscal years and its ability to continue
operating  as a going  concern is  dependent  upon  achieving  profitability  or
through additional debt or equity financing.  Achieving profitability is largely
dependent on sufficiently reducing operating costs and halting the current trend
of declining revenue.  The Company's ability to halt the declines in revenue and
restore its revenue base of revenue is largely dependent upon  restructuring its
sales and marketing  efforts in the refractory  angina market and operating in a
more  efficient  manner.  If the Company is not able to restore its revenue base
and sufficiently  reduce operating costs to generate an adequate cash inflow, or
raise additional capital, it will not be able to continue as a going concern.

     In order to reduce the  Company's  cash usage and bring its cost  structure
more into alignment with current revenue,  the Company initiated a restructuring
in January 2006, to reduce  personnel and spending on marketing and  development
projects. Additional cost reductions are continuing. In addition, in April 2006,
the  outside  directors  of the  Company  elected  to defer  payment of board of
director  meeting fees and senior officers elected to defer  approximately  $0.4
million in annual salary compensation. However, revenue has continued to decline
and the Company has not achieved its goal of profitability.

     Management  believes that cash flow from  operations  together with current
cash reserves will be sufficient to fund minimum projected capital  requirements
through at least the end of the calendar year.

     In the event that additional  capital is required,  the Company may seek to
raise such capital  through  public or private  equity or debt  financings or by
other  means.  The Company  may not be able to obtain  additional  financing  on
favorable  terms or at all. If the Company is unable to raise  additional  funds
when needed, it may need to further scale back operations,  research,  marketing
or sales  efforts  or  obtain  funds  through  arrangements  with  collaborative
partners or others that may require the Company to license or relinquish  rights
to technologies or products. Future capital funding, if available, may result in
dilution to current  shareholders,  and new investors could have rights superior
to existing stockholders.

     The accompanying  financial  statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     A summary of the significant  accounting policies  consistently  applied in
the preparation of the consolidated financial statements follows:

     Reclassifications

     Certain reclassifications have been made to prior years' amounts to conform
with the current year's presentation.

     Principles of Consolidation

     The consolidated  financial statements include the accounts of the Company,
its  wholly-owned  subsidiary  and  its  inactive   majority-owned   subsidiary.
Significant intercompany accounts and transactions have been eliminated.

     Revenue Recognition

     We recognize  revenue when  persuasive  evidence of an arrangement  exists,
delivery  has  occurred  or  service  has been  rendered,  the price is fixed or
determinable and collectibility is reasonably  assured. In the United States, we
recognize  revenue  from the sale of our EECP  systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies,  accessories and spare
parts  delivered  to both  domestic  and  international  customers.  Returns are
accepted prior to the in-service and training subject to a 10% restocking charge
or for normal warranty matters,  and we are not obligated for post-sale upgrades
to these systems.  In addition,  we use the installment method to record revenue

                                     F - 8
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

based on cash receipts in situations  where the account  receivable is collected
over an extended period of time and in our judgment the degree of collectibility
is uncertain.

     In most cases,  revenue from domestic  EECP system sales is generated  from
multiple-element  arrangements  that  require  judgment in the areas of customer
acceptance,  collectibility,  the  separability of units of accounting,  and the
fair value of individual  elements.  Effective September 1, 2003, we adopted the
provisions of Emerging  Issues Task Force,  or EITF,  Issue No. 00-21,  "Revenue
Arrangements  with  Multiple  Deliverables",  ("EITF  00-21"),  on a prospective
basis. The principles and guidance outlined in EITF 00-21 provide a framework to
determine (a) how the arrangement  consideration  should be measured (b) whether
the arrangement should be divided into separate units of accounting, and (c) how
the  arrangement  consideration  should be allocated among the separate units of
accounting.  We determined that the domestic sale of our EECP systems includes a
combination of three elements that qualify as separate units of accounting:
     i.   EECP equipment sale,
     ii.  provision of in-service and training  support  consisting of equipment
          set-up and training provided at the customer's facilities, and
     iii. a service  arrangement  (usually one year),  consisting of: service by
          factory-trained  service  representatives,  material  and labor costs,
          emergency  and  remedial  service  visits,  preventative  maintenance,
          software  upgrades,  technical  phone support and  preferred  response
          times.

     Each of these  elements  represent  individual  units of  accounting as the
delivered  item has value to a customer on a  stand-alone  basis,  objective and
reliable  evidence of fair value exists for undelivered  items, and arrangements
normally do not  contain a general  right of return  relative  to the  delivered
item. We determine fair value based on the price of the  deliverable  when it is
sold  separately  or based  on  third-party  evidence.  In  accordance  with the
guidance in EITF 00-21,  we use the residual  method to allocate the arrangement
consideration  when it does not have fair value of the EECP system  sale.  Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement  consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
     i.   EECP equipment  sales,  when delivery and  acceptance  occurs based on
          delivery  and  acceptance   documentation  received  from  independent
          shipping companies or customers,
     ii.  in-service  and  training,  following  documented  completion  of  the
          training,  and
     iii. the service  arrangement,  ratably over the service  period,  which is
          generally one year.

     In-service and training generally occurs within three weeks of shipment and
our return policy states that no returns will be accepted  after  in-service and
training has been  completed.  The amount  related to in-service and training is
recognized  as  equipment  revenue at the time the  in-service  and  training is
completed and the amount related to service  arrangements is recognized  ratably
over the related service period,  which is generally one year.  Costs associated
with the  provision of  in-service  and  training  and the service  arrangement,
including salaries,  benefits, travel, spare parts and equipment, are recognized
in cost of equipment sales as incurred.

     We also recognize revenue generated from servicing EECP systems that are no
longer covered by the service arrangement, or by providing sites with additional
training,  in the period that these  services are provided.  Revenue  related to
future  commitments under separately  priced extended service  agreements on our
EECP  system are  deferred  and  recognized  ratably  over the  service  period,
generally  ranging  from  one  year to four  years.  Costs  associated  with the
provision of service and  maintenance,  including  salaries,  benefits,  travel,
spare parts and equipment, are recognized in cost of sales as incurred.  Amounts
billed in excess of revenue  recognized are included as deferred  revenue in the
consolidated balance sheets.

     Revenues  from  the  sale  of  EECP  systems   through  our   international
distributor  network are generally  covered by a one-year warranty period. We do
not offer a service arrangement to international  customers;  consequently,  for
these  customers  we accrue a warranty  reserve for  estimated  costs to provide
warranty services when the equipment sale is recognized.

     We have also entered into lease agreements for our EECP systems,  generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized,  in accordance with the terms of
the lease agreements,  on a straight-line  basis over the life of the respective
leases.  For certain operating leases in which payment terms are determined on a

                                     F - 9
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

coverage  policy in  scope.  We  estimate  that over 300  private  insurers  are
reimbursing  for EECP  therapy for the  treatment  of angina  today at favorable
payment  levels  and we expect  that the number of  private  insurers  and their
related  health plans that  provide for EECP  therapy as a covered  benefit will
continue to increase.  In addition,  we are aware of two third-party payers that
have begun limited coverage of EECP therapy for the treatment of CHF.

     Accounts Receivable/Financing Receivables

     Our accounts receivable - trade are due from customers engaged in providing
medical  services.  Credit  is  extended  based on  evaluation  of a  customer's
financial  condition  and,  generally,  collateral  is  not  required.  Accounts
receivable  are  generally  due 30 to 90 days from  shipment  and are  stated at
amounts due from  customers net of allowances  for doubtful  accounts,  returns,
term  discounts  and other  allowances.  Accounts  outstanding  longer  than the
contractual  payment  terms  are  considered  past  due.  Estimates  are used in
determining  the  allowance  for  doubtful   accounts  based  on  the  Company's
historical  collections   experience,   current  trends,  credit  policy  and  a
percentage of our accounts  receivable by aging category.  In determining  these
percentages,  we look at historical write-offs of our receivables.  We also look
at the  credit  quality  of our  customer  base as well as changes in our credit
policies.  We continuously  monitor collections and payments from our customers.
While  credit  losses  have  historically  been  within   expectations  and  the
provisions established,  we cannot guarantee that we will continue to experience
the same credit loss rates that we have has in the past.

     The  changes  in the  Company's  allowance  for  doubtful  accounts  are as
follows:
<TABLE>
<CAPTION>
                                                                      Year Ended May 31,
                                                  -----------------------------------------------------------
                                                         2006                 2005                2004
                                                  -------------------    ---------------     ----------------
<S>                                                   <C>                    <C>                 <C>
Beginning balance                                     $394,692               $699,203            $768,629
    Provision for losses on accounts                   110,317
    receivable                                                                 11,084             616,759
    Direct write-offs, net of recoveries               (94,318)              (315,595)           (686,185)
                                                  -------------------    ---------------     ----------------
Ending balance                                        $410,691               $394,692            $699,203
                                                  ===================    ===============     ================
</TABLE>
     In addition, we periodically review and assess the net realizability of our
receivables  arising from sales-type  leases.  If this review results in a lower
estimate of the net  realizable  value of the  receivable,  an allowance for the
unrealized amount is established in the period in which the estimate is changed.
In the  second  quarter  of fiscal  2004,  we  decided  to  write-off  financing
receivables under sales-type leases of approximately $680,000,  respectively, as
a result of significant uncertainties with respect to this customer's ability to
meet its financial obligations. (See Note E).

     The changes in our  allowance for financing  receivables,  which  primarily
relates to balloon payments due at lease end, are as follows:
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2006               2005               2004
                                                  ---------------    ---------------    ---------------
<S>                                                       <C>                <C>           <C>
Beginning balance                                         $--                $--           $244,994
    Provision for losses on financing
      receivables                                          --                 --            680,000
    Direct write-offs                                      --                 --           (924,994)
                                                  ---------------    ---------------    ---------------
Ending balance                                            $--                $--                $--
                                                  ===============    ===============    ===============
</TABLE>
     Concentrations of Credit Risk

     We market the EECP system  principally  to hospitals and physician  private
practices.  We perform credit evaluations of its customers'  financial condition
and, as a  consequence,  believe  that our  receivable  credit risk  exposure is
limited.  Receivables  are  generally due 30 to 90 days from  shipment.  For the
years ended May 31, 2006 and 2005 and 2004,  no  customer  accounted  for 10% or
more of revenues. For the year ended May 31, 2006, no customer accounted for 10%
or more of accounts  receivable.  As of May 31, 2005, one customer accounted for
13% of accounts receivable.

                                     F - 10
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

         Our revenues were derived from the following geographic areas:
<TABLE>
<CAPTION>

                                                                    Year Ended May 31,
                                                   ------------------------------------------------------
                                                        2006                2005               2004
                                                   ---------------     ---------------    ---------------
<S>                                                 <C>                 <C>                  <C>
Domestic (United States)                            $10,079,789         $13,673,293          $21,339,267
Non-domestic (foreign)                                  863,208           1,422,485              867,770
                                                   ---------------     ---------------    ---------------
                                                    $10,942,997         $15,095,778          $22,207,037
                                                   ===============     ===============    ===============
</TABLE>
     Cash and Cash Equivalents

     Cash and cash  equivalents  represent  cash and  short-term,  highly liquid
investments in certificates of deposit,  treasury bills, money market funds, and
investment  grade  commercial  paper issued by major  corporations and financial
institutions  that generally have  maturities of three months or less.  Realized
and  unrealized  gains and losses and declines in value,  if any, are charged to
earnings.  Dividend and interest income are recognized when earned.  The cost of
securities sold is calculated  using the specific  identification  method.  (See
Note C)

     Certificates of Deposit

     Included in this caption are all certificates of deposit that have original
maturities  of greater  than three  months.  Realized and  unrealized  gains and
losses and declines in value,  if any,  are  included in earnings.  Dividend and
interest  income are  recognized  when earned.  The cost of  securities  sold is
calculated using the specific identification method. (See Note C)

     Inventories, net

     We value  inventory  at the lower of cost or estimated  market,  cost being
determined  on a  first-in,  first-out  basis.  We often  place EECP  systems at
various  field  locations for  demonstration,  training,  evaluation,  and other
similar purposes at no charge.  The cost of these EECP systems is transferred to
property  and  equipment  and is amortized  over the next two to five years.  We
record  the  cost  of  refurbished  components  of  EECP  systems  and  critical
components at cost plus the cost of refurbishment. We regularly review inventory
quantities on hand,  particularly  raw materials  and  components,  and record a
provision  for excess and  obsolete  inventory  based  primarily on existing and
anticipated design and engineering  changes to our products as well as forecasts
of future product demand.  Inventory on hand that exceeds two years requirements
based on forecasted demand is considered excess.

     Effective June 1, 2005, we adopted the provisions of Statement of Financial
Accounting  Standards No. 151,  "Inventory  Costs", on a prospective  basis. The
statement  clarifies that abnormal  amounts of idle facility  expense,  freight,
handling  costs,  and  wasted  materials  (spoilage)  should  be  recognized  as
current-period charges and requires the allocation of fixed production overheads
to inventory  based on the normal  capacity of the production  facilities.  As a
result of adopting  SFAS No.  151,  approximately  $256,000 in fixed  production
overheads was not absorbed into inventory at May 31, 2006. (See Note D)

     Property and Equipment

     Property and equipment are stated at cost less accumulated depreciation and
amortization.   Major  improvements  are  capitalized  and  minor  replacements,
maintenance  and repairs are charged to expense as incurred.  Upon retirement or
disposal of assets,  the cost and related  accumulated  depreciation are removed
from  the  consolidated  balance  sheets.  Depreciation  is  provided  over  the
estimated useful lives of the assets, which range from two to thirty-nine years,
on a straight-line  basis.  Accelerated methods of depreciation are used for tax
purposes. We amortize leasehold improvements over the useful life of the related
leasehold improvement or the life of the related lease,  whichever is less. (See
Note F)

     Deferred Revenues

     We record revenue on extended  service  contracts  ratably over the term of
the related  contracts.  In addition,  we defer  revenue  related to EECP system
sales for the fair value of installation  and in-service  training to the period
when the services are  rendered  and for service  arrangements  ratably over the
service period, which is generally one year. (See Note G)

                                     F - 11
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

     Warranty Costs

     Equipment sold in domestic  markets is generally  covered by a warranty and
service arrangement period of one year. For certain  arrangements,  a portion of
the overall system price  attributable to the first year service  arrangement is
deferred and  recognized as revenue over the service  period.  As such, we don't
accrue  warranty costs upon delivery but rather  recognize  warranty and related
service costs as incurred.

     Equipment sold to international  customers through our distributor  network
is generally  covered by a one-year  warranty period.  We do not offer a service
arrangement to  international  customers;  consequently,  for these customers we
accrue a warranty reserve for estimated costs to provide warranty  services when
the equipment sale is recognized.

     The factors affecting our warranty  liability  included the number of units
sold and historical  and  anticipated  rates of claims and costs per claim.  The
warranty provision  resulting from transactions prior to September 1, 2003, will
be reduced in future  periods for material  and labor costs  incurred as related
product is  returned  during the  warranty  period or when the  warranty  period
elapses. (See Note H)

     Research and Development

     Research  and  development  costs are  expensed  as  incurred.  Included in
research and development  costs is  amortization  expense related to the cost of
EECP systems under loan for clinical trials.

     Income Taxes

     Deferred  income taxes are  recognized  for temporary  differences  between
financial  statement  and income tax bases of assets  and  liabilities  and loss
carryforwards  for which  income tax  benefits  are  expected  to be realized in
future years. A valuation  allowance is established,  when necessary,  to reduce
deferred tax assets to the amount expected to be realized.  In estimating future
tax consequences, we generally consider all expected future events other than an
enactment  of  changes  in the tax laws or  rates.  The  deferred  tax  asset is
continually  evaluated for  realizability.  To the extent our judgment regarding
the  realization  of the  deferred  tax assets  changes,  an  adjustment  to the
allowance is recorded,  with an offsetting increase or decrease, as appropriate,
in income tax expense.  Such adjustments are recorded in the period in which our
estimate as to the  realizability  of the asset  changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not"  standard is  subjective,  and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.

     Deferred  tax   liabilities   and  assets  are  classified  as  current  or
non-current  based on the  classification  of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or  liability  for  financial  reporting,  including  deferred  tax assets
related to carryforwards, are classified according to the expected reversal date
of the  temporary  difference.  The  deferred tax asset we  previously  recorded
relates  primarily to the  realization of net operating loss  carryforwards,  of
which the  allocation  of the current  portion,  if any,  reflected the expected
utilization of such net operating  losses in the following  twelve months.  Such
allocation  was based on our internal  financial  forecast and may be subject to
revision based upon actual results. (See Note L)

     Shipping and Handling Costs

     All shipping  and handling  expenses are incurred as a component of cost of
sales.  Amounts  billed to customers  related to shipping and handling costs are
included as a component of sales.

     Fair Value of Financial Instruments

     The carrying amounts of cash and cash equivalents,  accounts receivable and
accounts payable approximate fair value due to the short-term  maturities of the
instruments.  The carrying amount of the financing receivables approximates fair
value as the interest  rates implicit in the leases  approximate  current market
interest rates for similar financial instruments.  The carrying amounts of notes
payable approximates their fair value as the interest rates of these instruments
approximate the interest rates  available on instruments  with similar terms and
maturities.

     Use of Estimates

     The  preparation  of financial  statements  in conformity  with  accounting
principles   generally  accepted  in  the  United  States  of  America  requires
management to make estimates and assumptions that affect the amounts reported in
the financial  statements  and  accompanying  notes.  Significant  estimates and
assumptions  relate to estimates of  collectibility  of accounts  receivable and

                                     F - 12
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

financing  receivables,  the  realizability  of  deferred  tax  assets,  and the
adequacy of inventory and warranty  reserves.  Actual  results could differ from
those estimates.

     Net Loss Per Common Share

     Basic  loss per share are based on the  weighted  average  number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share are based on the  weighted  number of common  and  potential  dilutive
common shares  outstanding.  The calculation  takes into account the shares that
may be issued upon the exercise of stock  options and  warrants,  reduced by the
shares that may be repurchased with the funds received from the exercise,  based
on the average price during the period

     Stock-Based Employee Compensation

     We have five  stock-based  employee and  director  compensation  plans.  We
account  for  stock-based  compensation  using  the  intrinsic  value  method in
accordance  with  Accounting  Principles  Board Opinion No. 25,  "Accounting for
Stock Issued to Employees," and related  Interpretations ("APB No. 25") and have
adopted the disclosure provisions of Statement of Financial Accounting Standards
No. 148,  "Accounting for Stock-Based  Compensation - Transition and Disclosure,
an  amendment  of FASB  Statement  No. 123." Under APB No. 25, when the exercise
price of our employee  stock options  equals the market price of the  underlying
stock on the date of grant, no compensation expense is recognized.  Accordingly,
no  compensation  expense  has been  recognized  in the  consolidated  financial
statements in connection with employee stock option grants.

     The following  table  illustrates the effect on net income and earnings per
share had we applied  the fair value  recognition  provisions  of  Statement  of
Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
Compensation," to stock-based employee compensation.
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2006               2005               2004
                                                  ---------------    ---------------    ---------------
<S>                                               <C>                 <C>                <C>
Net loss attributable to common shareholders,
as reported                                       $(11,579,011)       $(5,562,038)       $(3,422,520)
Deduct: Total stock-based employee compensation
   expense determined under fair value-based
   method for all awards                            (2,173,828)        (1,097,783)        (1,080,817)
                                                  ---------------    ---------------    ---------------
Pro forma net loss                                $(13,752,839)       $(6,659,821)       $(4,503,337)
                                                  ===============    ===============    ===============
Loss per share:
    Basic and diluted - as reported                  $(0.19)            $(0.10)             $(0.06)
    Basic and diluted - pro forma                    $(0.22)            $(0.11)             $(0.08)
</TABLE>
     For  purposes  of  estimating  the fair value of each option on the date of
grant,  the  Company  utilized  the  Black-Scholes   option-pricing  model.  The
Black-Scholes  option  valuation  model was developed for use in estimating  the
fair value of traded options,  which have no vesting  restrictions and are fully
transferable.  In addition,  option valuation models require the input of highly
subjective  assumptions  including the expected stock price volatility.  Because
the  Company's  employee  stock  options  have   characteristics   significantly
different  from those of traded  options and because  changes in the  subjective
input assumptions can materially affect the fair value estimate, in management's
opinion,  the  existing  models do not  necessarily  provide a  reliable  single
measure of the fair value of its employee stock options.

                                     F - 13
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

     The fair value of the Company's  stock-based  awards was estimated assuming
no expected dividends and the following weighted-average assumptions:
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2006               2005               2004
                                                  ---------------    ---------------     --------------
<S>                                                     <C>                <C>                 <C>
Expected life (years)                                     5                  5                   5
Expected volatility                                      83%                81%                 89%
Risk-free interest rate                                 4.5%               4.4%                3.4%
Expected dividend yield                                 0.0%               0.0%                0.0%
</TABLE>
     Equity  instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.

     Recently Issued Accounting Pronouncements Not Yet Effective

     In December 2004, the FASB issued Statement of Financial  Standards No. 123
(revised 2004), Share-Based Payment ("SFAS No. 123 (R)"), which is a revision of
SFAS No. 123. SFAS No. 123 (R)  supersedes  APB Opinion No. 25,  Accounting  for
Stock Issued to Employees,  and amends FASB Statement No. 95,  Statement of Cash
Flows.  Generally,  the approach to accounting for share-based  payments in SFAS
No. 123(R) is similar to the approach  described in SFAS No. 123. However,  SFAS
No. 123(R) requires all share-based  payments to employees,  including grants of
employee stock options,  to be recognized in the financial  statements  based on
their  fair  values.  Pro  forma  disclosure  of the fair  value of  share-based
payments is no longer an alternative to financial  statement  recognition.  SFAS
No.  123(R) is effective for small public  business  issuers at the beginning of
the first fiscal year beginning after December 15, 2005, and therefore effective
for the Company with the fiscal quarter ending August 31, 2006.

     In  May  2006,  the  compensation  committee  of  the  board  of  directors
accelerated the vesting  provision of all outstanding stock options and warrants
so that they were fully vested at May 31, 2006, as a result the Company  expects
the adoption of SFAS No. 123(R) to not to have an immediate  material  effect on
its  financial  statements,  however  as new on a stock  options  are issued the
Company  does  anticipate  the  adoption  of SFAS No 123(R) will have a material
effect  on its  quarterly  and  annual  financial  statements,  in the  form  of
additional  compensation  expense. It is not possible to precisely determine the
expense  impact of  adoption  since a portion of the  ultimate  expense  that is
recorded  will  likely  relate to awards  that  have not yet been  granted.  The
expense  associated  with these future  awards can only be  determined  based on
factors such as the price for the  Company's  common  stock,  volatility  of the
Company's  stock  price and risk free  interest  rates as  measured at the grant
date. However, the pro forma disclosures related to SFAS No. 123 included in the
Company's historic financial statements are relevant data points for gauging the
potential level of expense that might be recorded in future periods.

     Statement of Financial  Accounting  Standards No. 152, "Accounting for Real
Estate Time-Sharing Transactions",  an amendment of FASB Statements no 66 and 67
(SFAS 152) was issued in  December  2004 and  becomes  effective  for  financial
statements for fiscal years  beginning after June 15, 2005. The Company does not
expect that SFAS 152 will have an effect on future financial statements.

     In December  2004, the FASB issued FASB Statement No. 153 ("SFAS No. 153"),
"Exchanges  of  Non-monetary  Assets - an amendment of APB Opinion No. 29". SFAS
No. 153 amends Opinion 29 to eliminate the exception for non-monetary  exchanges
of  similar  productive  assets and  replaces  it with a general  exception  for
exchanges  of  non-monetary  assets  that do not have  commercial  substance.  A
non-monetary  exchange has commercial  substance if the future cash flows of the
entity are expected to change  significantly  as a result of the exchange.  SFAS
No. 153 is effective for fiscal  periods  after June 15, 2005.  The Company does
not  expect  the  adoption  of SFAS No.  153 to have a  material  impact  on the
Company's consolidated financial statements.

     In May 2005, the FASB issued  Statement of Financial  Accounting  Standards
No. 154 ("SFAS No. 154"),  "Accounting  Changes and Error Corrections." SFAS No.
154 replaces APB Opinion No. 20, Accounting  Changes,  and FASB Statement No. 3,
Reporting  Accounting Changes in Interim Financial  Statements,  and changes the
requirements  for the  accounting  for and  reporting of a change in  accounting
principle.  The  Statement  applies  to  all  voluntary  changes  in  accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition

                                     F - 14
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

provisions. When a pronouncement includes specific transition provisions,  those
provisions should be followed.  SFAS No. 154 is effective for accounting changes
and  corrections  of errors made in fiscal years  beginning  after  December 15,
2005.

     Statement of Financial Accounting Standards No. 155, Accounting for Certain
Hybrid Financial  Instruments--an  amendment of FASB Statements No. 133 and 140,
was issued in  February  2006 and is  effective  for all  financial  instruments
acquired or issued  after the  beginning  of an entity's  first fiscal year that
begins after September 15, 2006.  Certain parts of this Statement may be applied
prior to the adoption of this Statement. Earlier adoption is permitted as of the
beginning  of an entity's  fiscal  year,  provided the entity has not yet issued
financial statements,  including financial statements for any interim period for
that fiscal year.  Provisions of this  Statement  may be applied to  instruments
that an  entity  holds at the date of  adoption  on an  instrument-by-instrument
basis.  The  Company  does not  expect  that SFAS 155 will have any  significant
effect on future financial statements.

     Statement  of  Financial  Accounting  Standards  No.  156,  Accounting  for
Servicing of Financial  Assets--an amendment of FASB Statement No. 140, pertains
to the servicing of financial  assets and was issued in March 2006 and should be
adopted as of the beginning of its first fiscal year that begins after September
15,  2006.  Earlier  adoption is  permitted  as of the  beginning of an entity's
fiscal  year,  provided  the  entity has not yet  issued  financial  statements,
including interim financial statements,  for any period of that fiscal year. The
Company does not expect that SFAS 156 will have any significant effect on future
financial statements.

     In March 2005, FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement  Obligations--an  interpretation  of FASB Statement No. 143 (FIN 47).
FIN 47 is effective no later than the end of fiscal years ending after  December
15, 2005  (December  31, 2005,  for  calendar-year  enterprises).  Retrospective
application for interim financial  information is permitted but is not required.
Early adoption of this Interpretation is encouraged. The Company does not expect
that FIN 47 will have any significant effect on future financial statements.

     In December  2004,  the  Accounting  Standards  Executive  Committee of the
American Institute of Certified Public  Accountants  (AcSEC) issued Statement of
Position 04-2, Accounting for Real Estate Time-Sharing  Transactions (SOP 04-2).
SOP 04-2 is effective for financial statements issued for fiscal years beginning
after June 15, 2005, with earlier application  encouraged.  The Company does not
expect that SOP 04-2 will have any effect on future financial statements.

     In September 2005, AcSEC issued  Statement of Position 05-1:  Accounting by
Insurance   Enterprises  for  Deferred  Acquisition  Costs  in  Connection  with
Modifications  or  Exchanges  of  Insurance  Contracts  (SOP 05-1).  SOP 05-1 is
effective  for fiscal years  beginning  after  December  15, 2006,  with earlier
adoption  encouraged.  The  Company  does not expect that SOP 05-1 will have any
effect on future financial statements.

     FASB Staff  Position (FSP) FAS  13-1--Accounting  for Rental Costs Incurred
during a  Construction  Period,  was  issued on October  6,  2005,  and  becomes
effective for the for new  transactions or  arrangements  entered into after the
beginning of the first fiscal  quarter  following the date that the final FSP is
posted by the FASB.  The  Company  does not  expect  that FSP 13-1 will have any
significant effect on future financial statements.

     On June 29,  2005,  the FASB  ratified the  consensus  reached for Emerging
Issues Task Force (EITF)  Issue No. 05-5,  Accounting  for Early  Retirement  or
Postemployment  Programs  with  Specific  Features  (Such As Terms  Specified in
Altersteilzeit  Early  Retirement  Arrangements).  The  consensus  in this Issue
should be applied  to fiscal  years  beginning  after  December  15,  2005,  and
reported as a change in accounting  estimate  effected by a change in accounting
principle as described in paragraph 19 of FASB  Statement  154. The Company does
not expect that EITF 05-5 will have any significant  effect on future  financial
statements.

     On September 28, 2005,  the FASB  ratified the  consensus  reached for EITF
Issue No. 05-7,  Accounting for Modifications to Conversion  Options Embedded in
Debt  Instruments  and Related  Issues.  The  provisions of this Issue should be
applied  to future  modifications  of debt  instruments  beginning  in the first
interim or annual  reporting  period  beginning  after  December 15,  2005.  The
Company  expects  that the  application  of EITF  05-7  could  have an effect on
interest and debt valuations in future financial statements.  It is not possible
to determine the impact, if any, from the application since the Company does not
presently have any convertible debt.

                                     F - 15
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

     On September 28, 2005,  the FASB  ratified the  consensus  reached for EITF
Issue No.  05-8,  Income Tax  Consequences  of Issuing  Convertible  Debt with a
Beneficial  Conversion  Feature.  The provisions of this Issue should be applied
beginning  in the first  interim  or annual  reporting  period  beginning  after
December 15, 2005. The Company  expects that the  application of EITF 05-8 could
have an effect on he income tax expense reported in future financial statements.
It is not possible to determine the impact,  if any, from the application  since
the Company does not presently have any convertible debt.

     On July 13, 2006, the FASB issued  Interpretation No. 48 for Uncertainty in
Income  Taxes  and  interpretation  of FASB  Statement  109.  Interpretation  48
clarifies  the  accounting  for  uncertainty  in income  taxes  recognized  in a
company's  financial  statements  in  accordance  with  Statement  No.  109  and
prescribes a  recognition  threshold  and  measurement  attribute  for financial
statements  disclosure  of tax  position  taken or expected to be taken on a tax
return.  Additionally,  Interpretation No. 48 provides guidance on depreciation,
classification, interest and penalties accounting in interim periods, disclosure
and  transition.  Interpretation  No. 48 is effective for fiscal years beginning
after December 15, 2006, with early adoption permitted. The Company is currently
evaluating  whether the adoption of  Interpretation  No. 48 will have a material
effect on our consolidated  financial  position,  results of operations and cash
flows.

     In July 2006,  the FASB issued  Staff  Position  ("FSB") on FAS 13, FSP FAS
13-2,  Accounting  for a Change or Projected  Change in the Timing of Cash Flows
Relating to Income Taxes  Generated by a Leveraged  Lease  transaction.  FSP FAS
13-2  addresses  how a change or  projected  change in the  timing of cash flows
relating to income taxes generated by a leveraged lease transaction  affects the
accounting by a lessor for that lease and amends FAS 13  Accounting  for Leases.
FSP FAS 13-2 is effective  for fiscal years  beginning  December 15, 2006,  with
earlier  application  permitted.  The Company  does not expect that FSP FAS 13-2
will have any significant effect on future financial statements.

NOTE C -LOSS PER COMMON SHARE

     The following  table sets forth the  computation  of basic and diluted loss
per share:
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2006               2005               2004
                                                  ---------------    ---------------     --------------
<S>                                                <C>                 <C>                 <C>
Numerator:
   Net loss                                        $(11,579,011)       $(5,562,038)        $(3,422,520)
Denominator:
   Basic - weighted average shares                   61,351,323         58,547,574          57,981,963
         Stock options                                       --                 --                  --
         Warrants                                            --                 --                  --
                                                  ---------------    ---------------     --------------
   Diluted - weighted average shares                 61,351,323         58,547,574          57,981,963
                                                  ===============    ===============     ==============

Loss per share - basic                                   $(0.19)            $(0.10)             $(0.06)
                                                  ===============    ===============     ==============
               - diluted                                 $(0.19)            $(0.10)             $(0.06)
                                                  ===============    ===============     ==============
</TABLE>
     Options and warrants to purchase 10,466,613, 6,745,544 and 5,161,751 shares
of common stock were excluded from the computation of diluted earnings per share
for the years  ended May 31,  2006,  2005 and 2004,  respectively,  because  the
effect of their inclusion would be antidilutive.

NOTE D - CASH AND CASH EQUIVALENTS

         Cash and cash equivalents consist of the following:
<TABLE>
<CAPTION>
                                                         May 31,
                                           ----------------------------------
                                                2006                2005
                                           ---------------    ---------------
<S>                                           <C>                  <C>
Cash accounts                                 $2,383,312           $987,314
Money market funds                                 2,466              2,210
                                           ---------------    ---------------
                                              $2,385,778           $989,524
                                           ===============    ===============
</TABLE>
                                     F - 16
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

NOTE E - INVENTORIES, NET

         Inventories, net consist of the following:
<TABLE>
<CAPTION>
                                                                             May 31,
                                                                ----------------------------------
                                                                     2006               2005
                                                                ---------------    ---------------
<S>                                                                  <C>             <C>
Raw materials                                                        $863,952        $   960,101
Work in process                                                     1,243,986          1,194,688
Finished goods                                                        591,735          1,205,483
                                                                ---------------    ---------------
                                                                   $2,699,673         $3,360,272
                                                                ===============    ===============
</TABLE>
     At May 31, 2006 and 2005, the Company has recorded  reserves for excess and
obsolete inventory of $677,166 and $566,149, respectively.

NOTE F - PROPERTY AND EQUIPMENT

         Property and equipment is summarized as follows:
<TABLE>
<CAPTION>
                                                                             May 31,
                                                                -----------------------------------
                                                                     2006               2005
                                                                ---------------    ----------------
<S>                                                              <C>                <C>
Land                                                             $   200,000        $   200,000
Building and improvements                                          1,383,976          1,383,976
Office, laboratory and other equipment                             1,444,850          1,445,168
EECP systems  under  operating  leases or under loan
   for clinical trials                                               874,071          1,552,121
Furniture and fixtures                                               162,068            162,068
Leasehold improvements                                               117,803            117,803
                                                                ---------------    ----------------
                                                                   4,182,768          4,861,136
                                                                ---------------    ----------------
Less: accumulated depreciation and amortization                   (2,613,180)        (2,626,983)
                                                                ---------------    ----------------
                                                                  $1,569,588         $2,234,153
                                                                ===============    ================
</TABLE>
NOTE G - DEFERRED REVENUE

         The changes in the Company's deferred revenues are as follows:
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2006               2005               2004
                                                  ---------------    ---------------    ---------------
<S>                                                 <C>                <C>                <C>
Deferred revenue at beginning of year               $2,551,532         $2,846,451         $1,709,551
Additions
   Deferred extended service contracts               2,269,801          2,073,090          1,871,439
   Deferred in-service and training                    130,000            187,500            340,000
   Deferred service arrangement obligations            425,000            765,001          1,040,000
Recognized as revenue
   Deferred extended service contracts              (2,383,121)        (1,900,925)        (1,485,372)
   Deferred in-service and training                   (140,000)          (262,500)          (247,500)
   Deferred service arrangement obligations           (530,624)        (1,157,085)          (381,667)
                                                  ---------------    ---------------    ---------------
Deferred revenue at end of year                      2,322,588          2,551,532          2,846,451
   Less: current portion                            (1,600,887)        (1,667,080)        (1,734,925)
                                                  ---------------    ---------------    ---------------
Long-term deferred revenue at end of year             $721,701           $884,452         $1,111,526
                                                  ===============    ===============    ===============
</TABLE>
                                     F - 17
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004



NOTE H - WARRANTY LIABILITY

The changes in the Company's product warranty liability are as follows:
<TABLE>
<CAPTION>
                                                                    Year Ended May 31,
                                                  -------------------------------------------------------
                                                       2006                2005               2004
                                                  ---------------     ---------------    ----------------
<S>                                                    <C>                 <C>                <C>
Warranty liability at the beginning of the year        $118,333            $244,917           $788,000
  Expense for new warranties issued                      33,000              27,000            164,000
  Warranty claims                                      (119,333)           (153,584)          (707,083)
                                                  ---------------     ---------------    ----------------
Warranty liability at the end of the year                32,000             118,333            244,917
  Less: current portion                                 (30,500)           (110,583)          (161,917)
                                                  ---------------     ---------------    ----------------
Long-term warranty liability at the end of
the year                                                 $1,500              $7,750            $83,000
                                                  ===============     ===============    ================
</TABLE>
NOTE I - LONG-TERM DEBT AND LINE OF CREDIT AGREEMENT

         The following table sets forth the computation of long-term debt:
<TABLE>
<CAPTION>
                                                                             May 31,
                                                               ------------------------------------
                                                                    2006                2005
                                                               ----------------    ----------------
<S>                                                                 <C>                 <C>
Facility loans (a)                                                  $914,528            $969,566
Term loans (b)                                                        35,970             126,243
                                                               ----------------    ----------------
                                                                     950,498           1,095,809
Less:  current portion                                               (97,309)           (148,212)
                                                               ----------------    ----------------
                                                                    $853,189            $947,597
                                                               ================    ================
<FN>
     (a) The Company  purchased its  headquarters  and  warehouse  facility with
secured  notes of  $641,667  and  $500,000,  respectively,  under  two  programs
sponsored by New York State.  These notes,  which bear  interest at 7.8% and 6%,
respectively,  are payable in monthly  installments  consisting of principal and
interest  payments  over  fifteen-year  terms,  expiring in  September  2016 and
January 2017, respectively, and are secured by the building.
     (b) In  fiscal  years  2003 and 2004,  the  Company  financed  the cost and
implementation  of a management  information  system and secured  several notes,
aggregating  approximately  $305,219.  The notes,  which bear  interest at rates
ranging from 7.5% through 12.5%, are payable in monthly installments  consisting
of principal and interest  payments over  four-year  terms,  expiring at various
times between August and October 2006.
</FN>
</TABLE>
         Maturities of long-term debt are as follows at May 31, 2006:
<TABLE>
<CAPTION>
                Fiscal Year                  Amount
                -------------------     --------------
                <S>                          <C>
                2007                          $97,309
                2008                           65,769
                2009                           70,426
                2010                           75,629
                2011                           81,110
                Thereafter                    560,255
                                        --------------
                                             $950,498
                                        ==============
</TABLE>
NOTE J - SERIES D PREFERRED STOCK AND WARRANTS

     On July 19,  2005,  we entered into a Securities  Purchase  Agreement  that
provided us with gross proceeds of $2.5 million  through a private  placement of
preferred stock with M.A.G.  Capital,  LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the  "Investors").  The  agreement  provided for a private  placement of 25,000
shares  of  Vasomedical's  Series  D  Preferred  Stock at $100  per  share.  The
preferred stock was convertible into shares of Vasomedical's  common stock at 85

                                     F - 18
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004



percent of the volume weighted average price per share for the five trading days
preceding  any  conversion,  but not at more than $0.6606 or less than $0.40 per
share. The Investors also acquired warrants for the purchase of 1,892,219 shares
of common stock. The warrants may be exercised at a price of $0.69 per share for
a term of five years,  ending July 19, 2010. As of February 28, 2006, all of the
Series D Preferred  Stock had been  converted  into  6,112,209  shares of common
stock.

     Under the terms of a  Registration  Rights  Agreement  with the  Investors,
Vasomedical  filed a Form S-3  registration  statement  with the  Securities and
Exchange  Commission  (SEC) on August 22, 2005, for 10,787,871  shares of common
stock representing up to 8,533,333 shares issuable in connection with conversion
of our Series D Convertible  Preferred Stock and up to 2,254,538 shares issuable
upon the exercise of our common stock  purchase  warrants.  The SEC declared the
registration  statement  effective  on  September  1, 2005.  The total number of
shares  registered  was based on a  conversion  price of $0.30 per share,  which
would only have affect in the event of default by  Vasomedical of its obligation
to holders of the Series D Convertible Preferred Stock.

     These  securities  were  offered  and sold to the  Investors  in a  private
placement  transaction  made  in  reliance  upon  exemptions  from  registration
pursuant  to Section  4(2) of the  Securities  Act of 1933.  The  Investors  are
accredited  investors as defined in Rule 501 of Regulation D  promulgated  under
the Securities Act of 1933. Vasomedical applied the funds to working capital.

     Warrants and Beneficial Conversion Feature

     The Company applied  Emerging Issues Task Force Issue No. 98-5  "Accounting
for Convertible  Securities with Beneficial  Conversion Features or Contingently
Adjustable  Conversion  Ratios"(EITF  No. 98-5) and  Emerging  Issues Task Force
(EITF 00-27) Application of Issue No. 98-5 to Certain Convertible Instruments in
accounting  for the  preferred  stock  issuance.  EITF No.  98-5  provides  that
detachable  warrants issued with convertible  securities are valued  separately,
and that the  beneficial  conversion  feature  of the  convertible  security  be
measured and recognized over the minimum period over which the  shareholders can
realize the return.

     The Task Force reached a consensus that  convertible  preferred  securities
with a non-detachable  conversion feature that is in-the-money at the commitment
date  represents  an  embedded  beneficial  conversion  feature  that  should be
recognized as a dividend and recorded to additional paid-in capital. That amount
should be  calculated  at the  commitment  date as the  difference  between  the
allocated  portion of the gross proceeds to the convertible  preferred stock and
the fair value of the common stock or other  securities  into which the security
is  convertible,  multiplied  by the number of shares into which the security is
convertible (intrinsic value method).

     The beneficial conversion feature is treated analogous to a dividend and is
recognizable  immediately  over the minimum  period  during which the  preferred
shareholders  can realize that return.  The imputed  dividend  will increase the
Company's  loss for the purpose of computing  the  loss-per-share  applicable to
common  shareholders.  The  beneficial  conversion  feature is calculated at its
intrinsic  value at the  commitment  date (that is, the  difference  between the
total gross proceeds  allocated to the preferred  stock as compared to the total
market value of the common stock into which the Preferred  Stock is  convertible
on the commitment date). The computed value of the beneficial conversion feature
is treated as a deemed dividend  immediately  with a  corresponding  increase to
paid-in capital.  No additional amount will be recognized at the conversion date
in recognition of an increase in the fair value of the stock conversion.

     In circumstances in which convertible securities are issued with detachable
warrants,  the Task  Force  noted  that in order to  determine  the amount to be
allocated to the beneficial  conversion feature,  the issuer must first allocate
the proceeds  between the  convertible  instrument and the  detachable  warrants
using the relative fair value method of APB Opinion Number 14.

                                     F - 19
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

     The investors and consultants acquired detachable warrants for the purchase
of 1,892,219 and 362,319 shares of common stock, respectively, which were valued
at $345,071 and $66,087,  respectively. The warrants may be exercised at a price
of $0.69 per share for a term of five years,  ending July 18, 2010. For purposes
of estimating  the intrinsic  fair value of each warrant as of July 19, 2005, we
utilized the Black-Scholes  option-pricing model. We estimated the fair value of
the warrants assuming no expected  dividends and the following  weighted-average
assumptions:
<TABLE>
        <S>                                            <C>
        Expected life (years)                            2.5
        Expected volatility                              66%
        Risk-free interest rate                        4.16%
        Expected dividend yield                         0.0%
</TABLE>
     We next  determined the intrinsic fair value of the  convertible  preferred
stock as of July 19, 2005, to be $2,941,176 based on the number of common shares
that could be acquired as of the date of closing times $0.63,  the closing price
of the  common  stock on the date  preceding  the close of the  transaction.  In
applying  EITF No. 98-5,  we then  allocated  the gross  proceeds of  $2,500,000
between  the  warrants  and  preferred  stock based on  intrinsic  value of each
instrument.  As a result,  we  allocated  $2,154,929  of gross  proceeds  to the
convertible  preferred  stock  and  $345,071  to the  detachable  warrants.  The
beneficial conversion feature of $786,247 was then determined by subtracting the
allocated proceeds of convertible  preferred stock from the intrinsic fair value
of  convertible   preferred  stock.  The  beneficial   conversion   feature  was
immediately recognized as a preferred stock dividend, as the preferred stock can
be converted immediately.

     Dividends
     By the placement of the convertible  preferred  stock  described  above, we
became  obligated to pay a cash dividend  monthly on the  outstanding  shares of
convertible  preferred  stock.  The dividend rate is the higher of (i) the prime
rate as reported by the Wall Street Journal on the first day of the month,  plus
three  percent or, (ii) 8.5% times $100 per share,  but in no event greater than
10% annually.  For the fiscal year ended May 31, 2006, cash dividends of $91,623
were paid.  Preferred  stock  dividends  for the fiscal 2006 are  summarized  as
follows:
<TABLE>
<CAPTION>
                                            Amount
                                            ------
<S>                                       <C>
Cash dividends paid                        $91,623
Beneficial conversion feature              786,247
                                       --------------
                                          $877,870
                                       ==============
</TABLE>
     Common stock
     The  Company  issued  200,000  shares of  common  stock in lieu of cash for
$126,000 in  consultant  services  associated  with the issuance of the Series D
Convertible  Preferred  Stock.  These issue costs were treated as a reduction in
the paid-in capital associated with the preferred stock issuance.

NOTE K - STOCKHOLDERS' EQUITY AND WARRANTS

     No warrants  were  exercised or cancelled in fiscal 2004 and 2005.  On July
19, 2005,  we granted  warrants  for the purchase of 2,254,538  shares of common
stock to  investors  and  consultants  associated  with the issuance of Series D
Preferred Stock, (See Note J). The warrants may be exercised at a price of $0.69
per share for a term of five years,  ending July 19, 2010. The remaining 200,000
warrants expire in October 2006.

         Warrant activity for the years ended May 31, 2004, 2005 and 2006 is
summarized as follows:
<TABLE>
<CAPTION>
                                       Employees         Consultants               Total             Price Range
                                    ----------------- ------------------- ------------------------ ----------------
<S>                                            <C>        <C>                   <C>                     <C>
Balance at May 31, 2004                        --           200,000               200,000               $0.91
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005                        --           200,000               200,000               $0.91
                                    ----------------- ------------------- ------------------------ ----------------
  Warrants granted                                        2,254,538             2,254,538               $0.69
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2006                        --         2,454,538             2,454,538               $0.71
                                    ================= =================== ======================== ================
Number of shares exercisable                   --         2,454,538             2,454,538               $0.71
                                    ================= =================== ======================== ================
</TABLE>
                                     F - 20
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

NOTE L - OPTION PLANS

     1995 Stock Option Plan
     In May 1995, the Company's stockholders approved the 1995 Stock Option Plan
for officers and  employees  of the Company,  for which the Company  reserved an
aggregate of 1,500,000  shares of common stock.  In December 1997, the Company's
Board of  Directors  terminated  the 1995 Stock  Option Plan with respect to new
option grants.

     In fiscal 2006,  options to purchase  155,000  shares of common stock at an
exercise  price of $3.44  under  the 1995  Stock  Option  Plan were  retired  or
cancelled

     Outside Director Stock Option Plan
     In May 1995, the Company's  stockholders approved an Outside Director Stock
Option Plan (the "OD Plan") for non-employee directors of the Company, for which
the Company reserved an aggregate of 300,000 shares of common stock. In December
1997,  the Company's  Board of Directors  terminated the OD Plan with respect to
new option grants.

     In fiscal  2005,  options to purchase  38,709  shares of common stock at an
exercise price of $0.78 under the OD Plan were retired unexercised.

     In fiscal 2006,  options to purchase  155,000  shares of common stock at an
exercise price of $2.21 under the OD Plan were retired unexercised.

     1997 Stock Option Plan
     In December 1997, the Company's stockholders approved the 1997 Stock Option
Plan (the "1997 Plan") for officers, directors, employees and consultants of the
Company,  for which the Company has reserved an aggregate of 1,800,000 shares of
common stock.  The 1997 Plan provides that a committee of the Board of Directors
of the  Company  will  administer  it and  that the  committee  will  have  full
authority to determine  the  identity of the  recipients  of the options and the
number of shares subject to each option. Options granted under the 1997 Plan may
be either  incentive stock options or  non-qualified  stock options.  The option
price shall be 100% of the fair market  value of the common stock on the date of
the grant (or in the case of incentive  stock options  granted to any individual
principal  stockholder  who owns  stock  possessing  more  than 10% of the total
combined  voting  power of all voting  stock of the  Company,  110% of such fair
market  value).  The term of any option may be fixed by the  committee but in no
event shall  exceed ten years from the date of grant.  Options  are  exercisable
upon  payment in full of the exercise  price,  either in cash or in common stock
valued at fair market value on the date of exercise of the option.  The term for
which options may be granted under the 1997 Plan expires August 6, 2007.

     In January 1999, the Company's  Board of Directors  increased the number of
shares  authorized  for  issuance  under  the 1997 Plan by  1,000,000  shares to
2,800,000 shares.

     In May 2006, the Board of Directors  accelerated the vesting period for all
unvested options to May 31, 2006.

     In fiscal 2004, options to purchase 75,667 shares of common stock under the
1997 Plan were  exercised at an exercise  price of $0.88 per share,  aggregating
$66,209 of proceeds to the  Company  and options to purchase  350,000  shares of
common  stock under the 1997 Plan at an exercise  price of $0.88 were retired or
cancelled.

     In fiscal 2005,  the  Company's  Board of Directors  granted  non-qualified
stock  options  under the 1997 Plan to an officer to  purchase an  aggregate  of
153,168 shares of common stock,  at an exercise price of $1.09 per share,  which
represented the fair market value of the underlying  common stock at the time of
the respective grants. These options expire ten years from the date of grant. In
fiscal  2005,  options to purchase  4,500  shares of common stock under the 1997
Plan at an exercise price of $0.88 were cancelled.

     In fiscal 2006,  options to purchase 4,500 shares of common stock under the
1997 Plan at  exercise  prices  ranging  from  $0.88 to $1.91  were  retired  or
cancelled.

     At May 31, 2006,  there were 303,168  shares  available  for future  grants
under the 1997 Plan.

     1999 Stock Option Plan
     In July 1999,  the  Company's  Board of  Directors  approved the 1999 Stock
Option Plan (the "1999  Plan"),  for which the Company  reserved an aggregate of
2,000,000 shares of common stock. The 1999 Plan provides that a committee of the
Board of Directors of the Company will administer it and that the committee will
have full  authority to determine the identity of the  recipients of the options
and the number of shares subject to each option.  Options granted under the 1999
                                     F - 21
<PAGE>
                       Vasomedical, Inc. and Subsidiaries
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           May 31, 2006, 2005 and 2004

Plan may be either incentive stock options or non-qualified  stock options.  The
option  price shall be 100% of the fair market  value of the common stock on the
date of the grant (or in the case of  incentive  stock  options  granted  to any
individual principal  stockholder who owns stock possessing more than 10% of the
total  combined  voting power of all voting  stock of the Company,  110% of such
fair market value).  The term of any option may be fixed by the committee but in
no event shall exceed ten years from the date of grant.  Options are exercisable
upon  payment in full of the exercise  price,  either in cash or in common stock
valued at fair market value on the date of exercise of the option.  The term for
which  options may be granted under the 1999 Plan expires July 12, 2009. In July
2000, the Company's Board of Directors increased the number of shares authorized
for issuance  under the 1999 Plan by 1,000,000  shares to 3,000,000  shares.  In
December  2001,  the Board of Directors of the Company  increased  the number of
shares  authorized  for  issuance  under  the 1999 Plan by  2,000,000  shares to
5,000,000 shares.

     In May 2006, the Board of Directors  accelerated the vesting period for all
unvested options to May 31, 2006.

     In fiscal 2004, the Board of Directors granted  non-qualified stock options
under the 1999 Plan to  directors  and  employees  to purchase an  aggregate  of
725,000 shares of common stock, at exercise  process ranging from $0.91 to $1.31
per shares (which  represented  the fair market value of the  underlying  common
stock at the time of the respective grants). In fiscal 2004, options to purchase
521,666 shares of common stock under the 1999 Plan were exercised at an exercise
price of $0.71 to $1.22 per  share,  aggregating  $631,178  of  proceeds  to the
Company and options to purchase  956,669  shares of common  stock under the 1999
Plan at an exercise price of $0.91 to $5.15 were retired or cancelled.

     In fiscal 2005,  the  Company's  Board of Directors  granted  non-qualified
stock options to  directors,  officers and employees to purchase an aggregate of
2,194,832  shares of common  stock,  at an exercise  price of $0.95 to $1.70 per
share, which represented the fair market value of the underlying common stock at
the time of the respective  grants.  Some of these options vest  immediately and
others vest or over  three-year  or  four-year  periods.  Some of these  options
expire in five years and  others in ten years from the date of grant.  In fiscal
2005,  options to purchase  133,332  shares of common  stock under the 1999 Plan
were exercised at an exercise price of $0.98 per share,  aggregating $130,666 of
proceeds to the Company and options to purchase  662,666  shares of common stock
under the 1999  Plan at an  exercise  price of $0.91 to $4.69  were  retired  or
cancelled.

     In fiscal 2006,  the  Company's  Board of Directors  granted  non-qualified
stock  options to purchase  under the 1999 Plan to an  Officers,  directors  and
employees to purchase an aggregate of 1,260,000  shares of common  stock,  at an
exercise price of $0.20 to $0.22 per share,  which  represented  the fair market
value of the underlying common stock at the time of the respective grants. These
ten years from the date of grant. In fiscal 2006,  options to purchase 1,173,250
shares of common  stock  under  the 1999 Plan at an  exercise  price of $0.20 to
$4.69 were retired or cancelled.

     At May 31, 2006, there were 23,253 shares available for future grants under
the 1999 Plan.

     2004 Stock Option and Stock Issuance Plan
     In October 2004, the Company's  stockholders approved the 2004 Stock Option
and Stock  Issuance  Plan (the "2004 Plan"),  for which the Company  reserved an
aggregate of 2,500,000 shares of common stock. The 2004 Plan is divided into two
separate  equity  programs:  (i) the Option Grant Program  under which  eligible
persons  ("Optionees")  may, at the  discretion  of the board of  directors,  be
granted options to purchase shares of common stock;  and (ii) the Stock Issuance
Program under which eligible persons  ("Participants") may, at the discretion of
the board or  directors,  be issued  shares of  common  stock  directly,  either
through  the  immediate  purchase  of such  shares  or as a bonus  for  services
rendered to the Corporation.

     Options  granted  under  the 2004  Stock  Plan  shall be  non-qualified  or
incentive  stock options and the exercise  price is the fair market value of the
common stock on the date of grant  except that for  incentive  stock  options it
shall be 110% of the fair market value if the  Optionee  owns 10% or more of our
common  stock.  The term of any option may be fixed by the board of directors or
committee  but in no event shall exceed ten years from the date of grant.  Stock
options  granted  under  the 2004  Plan may  become  exercisable  in one or more
installments  in the manner and at the time or times specified by the committee.
Options are exercisable  upon payment in full of the exercise  price,  either in
cash or in common  stock  valued at fair market value on the date of exercise of
the  option.  The term for  which  options  may be  granted  under the 2004 Plan
expires July 12, 2014.

     Under the stock  issuance  program,  the purchase  price per share shall be
fixed by the board of directors  or  committee  but cannot be less than the fair
market value of the common stock on the  issuance  date.  Payment for the shares
may be made in cash or check payable to us, or for past services  rendered to us
and all shares of common stock issued thereunder shall vest upon issuance unless
                                     F - 22
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

otherwise  directed  by the  committee.  The number of shares  issuable  is also
subject to adjustments  upon the occurrence of certain  events,  including stock
dividends,    stock   splits,    mergers,    consolidations,    reorganizations,
recapitalizations,  or other capital adjustments.  The term for which shares may
be issued under the 2004 Plan expires July 12, 2014.

     The 2004 Plan  provides  that a committee  of the Board of Directors of the
Company will  administer it and that the committee  will have full  authority to
determine and designate the  individuals  who are to be granted stock options or
qualify to purchase shares of common stock under the 2004 Stock Plan, the number
of shares to be subject to options or to be  purchased  and the nature and terms
of the options to be granted.  The committee also has authority to interpret the
2004 Plan and to prescribe, amend and rescind the rules and regulations relating
to the 2004 Plan.

     In May 2006, the Board of Directors  accelerated the vesting period for all
unvested options to May 31, 2006.

     In fiscal 2005,  the  Company's  Board of Directors  granted  non-qualified
stock  options  under the 2004 Plan to  directors  to purchase an  aggregate  of
225,000 shares of common stock,  at an exercise price of $0.95 per share,  which
represented the fair market value of the underlying  common stock at the time of
the respective grants.  Some of these options vest immediately and others over a
four-year period, and expire ten years from the date of grant.

     In fiscal 2006,  the Company's  Board of Directors  granted an aggregate of
225,000  shares of common  stock  under the 2004 Plan  directors  of the Company
having a fair  market  value of $0.45  per  share at the time of the  respective
grants. In fiscal 2006, the Company's Board of Directors  granted  non-qualified
stock  options  under the 2004 Plan to  Officers  and  employees  to purchase an
aggregate of 2,118,045  shares of common stock,  at exercise  prices of $0.20 to
$0.58 per share,  which  represented  the fair  market  value of the  underlying
common stock at the time of the  respective  grants.  These  options  expire ten
years from the date of grant. In fiscal 2006, options to purchase 266,496 shares
of common  stock under the 2004 Plan at  exercise  prices of $0.45 to $0.58 were
retired or cancelled.

     At May 31, 2006,  there were 423,451  shares  available  for future  grants
under the 2004 Plan.

     Activity  under all the plans for the years  ended May 31,  2004,  2005 and
2006, is summarized as follows:
<TABLE>
<CAPTION>
                                                                          Outstanding Options
                                                      -------------------------------------------------------------
                                         Shares                                                       Weighted
                                     Available for     Number of Shares          Exercise              Average
                                         Grant                                Price per Share      Exercise Price
                                    ----------------- ------------------- ------------------------ ----------------
<S>                                     <C>                 <C>               <C>                          <C>
Balance at May 31, 2003                 1,438,668           5,990,753         $0.71  -   $5.15             $2.13
  Options granted                        (725,000)            725,000         $0.92  -   $1.31             $1.06
  Options exercised                            --            (597,333)        $0.71  -   $1.22             $1.17
  Options canceled                      1,306,669          (1,306,669)        $0.88  -   $5.15             $1.61
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004                 2,020,337           4,811,751         $0.71  -   $5.15             $1.98
  Options/shares authorized             2,500,000 (1)              --               --                     --
  Options granted                      (2,573,000)          2,573,000         $0.951 -   $1.70             $1.08
  Options exercised                            --            (133,332)             $0.98                   $0.98
  Options canceled                        667,166            (705,875)        $0.78  -   $4.69             $2.03
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005                 2,614,503           6,545,544         $0.71  -   $5.15             $1.86
  Common shares granted                  (225,000)                 --               --                     --
  Options granted                      (3,378,045)          3,378,045         $0.20  -   $0.58             $0.34
  Options exercised                            --                  --               --
  Options canceled                      1,738,414          (1,911,514)        $0.20  -   $5.15             $0.70
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2006                   749,872           8,012,075         $0.20  -   $5.15             $1.20
                                    ================= =================== ======================== ================
<FN>
     (1) May be issued under the Stock  Issuance  Program.
</FN>
</TABLE>
                                     F - 23
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

     The following table summarizes  information about stock options outstanding
and exercisable at May 31, 2006
<TABLE>
<CAPTION>
                                             Options Outstanding                           Options Exercisable
                              ---------------------------------------------------    --------------------------------
                                                    Weighted
                                                     Average         Weighted                            Weighted
                                   Number           Remaining        Average              Number          Average
                               Outstanding at      Contractual    Exercise Price      Exercisable at     Exercise
  Range of Exercise Prices      May 31, 2006       Life (yrs.)                         May 31, 2006        Price
                              ------------------ ---------------- ---------------    ----------------- --------------
<C>                                 <C>                 <C>             <C>              <C>                 <C>
$0.20  -  $0.58                     2,971,549           9.6             $0.33            2,971,549           $0.33
$0.71  -  $0.97                     1,098,750           5.8             $0.90            1,098,750           $0.90
$1.00  -  $1.49                     2,129,167           7.3             $1.10            2,129,167           $1.10
$1.53  -  $2.49                       679,609           2.1             $1.87              679,609           $1.87
$2.66  -  $5.15                     1,133,000           3.6             $3.59            1,133,000           $3.59
                              ------------------ ---------------- ---------------    ----------------- --------------
                                    8,012,075           7.0             $1.20            8,012,075           $1.20
                              ================== ================ ===============    ================= ==============
</TABLE>
     The  weighted-average  fair value of options  granted  during  fiscal years
2006, 2005 and 2004 was $0.34, $1.08, and $1.06, respectively.  At May 31, 2006,
there were approximately  33,584,075 remaining authorized shares of common stock
after reserves for all stock option plans and stock warrants.

NOTE M - INCOME TAXES

     During the fiscal  years  ended May 31,  2006,  2005 and 2004,  we recorded
income tax expense of $7,109,176, 39,661 and $50,640,  respectively.  The fiscal
2006 tax expense consists mainly of $7,093,000 in additional valuation allowance
provided for the deferred tax asset in the second fiscal quarter. The income tax
expense for fiscal 2006 does not include  $7,489,000  added to the  deferred tax
valuation  allowance for tax benefits  associated with prior years' exercises of
stock options and  warrants,  which was charged  directly to additional  paid-in
capital.

     As of May 31, 2005, we had recorded  deferred tax assets of $14,582,000 net
of a $3,774,000  valuation allowance related to the anticipated  recovery of tax
loss  carryforwards.  No deferred tax assets have been recorded for state income
tax NOL's since it was  determined  that the amounts  were not  material and the
Company could not be sure that any benefit from the NOL's would be utilized.

     On December 20, 2005,  Centers for  Medicare  and Medicaid  Services  (CMS)
issued a Proposed  Decision  Memorandum (PDM) for External  Counterpulsation  in
response  to  Vasomedical's  application  to expand  reimbursement  coverage  to
include  Canadian  Cardiovascular  Society  (CCSC)  Class II angina and New York
Heart  Association  (NYHA) Class II/III  congestive heart failure (CHF). The PDM
stated  that  the  evidence  was  not   adequate  to  conclude   that   external
counterpulsation  therapy is reasonable  and  necessary to expand  reimbursement
coverage  to CCSC  Class II angina and NYHA  Class  II/III CHF and that  current
coverage  for CCSC  class  III/IV  refractory  angina  would  remain in  effect.
Consequently,  at the end of the  second  fiscal  quarter  of  fiscal  2006,  we
concluded that,  based upon the weight of available  evidence,  it was no longer
"more likely than not" that the net deferred tax asset of  $14,582,000  would be
realized,  and added  $14,582,000  to the  valuation  allowance to bring the net
deferred tax asset  carrying  value to zero.  On March 20, 2006,  CMS issued its
final decision, which upheld the PDM.

     As of May 31,  2006,  the  recorded  deferred  tax asset  was  $19,559,458,
reflecting an increase of $1,203,458 during fiscal 2006, which was offset by the
valuation allowance of the same amount.

                                     F - 24
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

         The Company's deferred tax assets are summarized as follows:
<TABLE>
<CAPTION>
                                                       2006               2005               2004
                                                  ---------------    ---------------    ---------------
<S>                                                 <C>                <C>                <C>
Net operating loss and other carryforwards          $17,850,000        $16,489,000        $14,468,000
      Accrued compensation                                6,900             68,000            118,000
      Bad debts                                         140,000            134,000            238,000
      Other                                           1,562,558          1,665,000          1,666,000
                                                  ---------------    ---------------    ---------------
Total gross deferred tax assets                      19,559,458         18,356,000         16,490,000
      Valuation allowance                           (19,559,458)        (3,774,000)        (1,908,000)
                                                  ---------------    ---------------    ---------------
Net deferred tax assets                                      --        $14,582,000        $14,582,000
                                                  ===============    ===============    ===============
</TABLE>
                                     F - 25

<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004

     At May 31,  2006,  the Company had net  operating  loss  carryforwards  for
Federal and state income tax purposes of approximately $52,108,005,  expiring at
various  dates from 2007 through  2026. In fiscal 2006 $336,198 of net operating
loss carryforwards  expired.  Expiration of net operating loss carryforwards are
as follows:
<TABLE>
<CAPTION>

                Fiscal Year                 Amount
            -------------------         --------------

                <S>                       <C>
                2007                         $517,934
                2008                          558,968
                2009                          470,994
                2010                        2,454,162
                2011                        5,449,051
                Thereafter                 42,656,286
                                        --------------
                                          $52,107,395
                                        ==============
</TABLE>
     Under current tax law, the utilization of tax attributes will be restricted
if an ownership change, as defined,  were to occur.  Section 382 of the Internal
Revenue Code  provides,  in general,  that if an "ownership  change" occurs with
respect to a corporation with net operating and other loss  carryforwards,  such
carryforwards  will be available to offset  taxable  income in each taxable year
after the ownership change only up to the "Section 382 Limitation" for each year
(generally,  the product of the fair market value of the corporation's  stock at
the time of the  ownership  change,  with certain  adjustments,  and a specified
long-term  tax-exempt bond rate at such time). The Company's  ability to use its
loss carryforwards would be limited in the event of an ownership change.

     The following is a  reconciliation  of the effective income tax rate to the
federal statutory rate:
<TABLE>
<CAPTION>
                                               2006             2005              2004
                                                 %                 %                %
                                          ----------------- ---------------- -----------------
<S>                                            <C>               <C>              <C>
Federal statutory rate                         (34.0)            (34.0)           (34.0)
State taxes, net                                 0.3               0.7              1.5
Permanent differences                            0.6               0.6              0.8
Change in valuation allowance
  relating to operations                       229.0              34.3             38.1
Other                                           (0.6)             (0.9)            (4.9)
                                          ----------------- ---------------- -----------------
                                              (195.3)              0.7              1.5
                                          ================= ================ =================
</TABLE>
NOTE N - COMMITMENTS AND CONTINGENCIES

     Employment Agreements

     In December 2005, the Company entered into an agreement with Thomas W. Fry,
Chief  Financial  Officer of the company,  which  entitled him to twelve  months
salary in the event of his termination without cause.

     In April 2006,  the  Company  approved a program to defer  compensation  of
certain  senior  executives  of the  company  and  incentives  to them for these
deferrals.  The Company agreed to repay monies  deferred from zero to six months
at 1.5 times the amount deferred;  for deferrals of six months to twelve months,
the repaid amount shall be two times the amount  deferred;  and for deferrals in
excess of twelve months,  the amount shall be 2.5 times the amount deferred.  In
addition, payment of board of directors meeting fees were deferred until a later
date.

     Leases

     The    Company    leases    additional     warehouse    space    under    a
noncancelable-operating  lease,  which one expires on September  30, 2006.  Rent
expense  was  $94,000,  $93,000  and  $72,000  in  fiscal  2006,  2005 and 2004,
respectively.  The  remaining  minimum  obligation  under  lease  agreements  is
$14,238.
                                     F - 26
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2006, 2005 and 2004


     Litigation

     The  Company  is  currently,  and has been in the past,  a party to various
routine  legal  proceedings  incident to the ordinary  course of  business.  The
Company  believes that the outcome of all such pending legal  proceedings in the
aggregate  is  unlikely  to have a material  adverse  effect on the  business or
consolidated financial condition of the Company.

NOTE O - 401(K) PLAN

     In April 1997, the Company  adopted the  Vasomedical,  Inc.  401(k) Plan to
provide retirement  benefits for its employees.  As allowed under Section 401(k)
of the Internal Revenue Code, the plan provides  tax-deferred  salary deductions
for  eligible  employees.  Employees  are  eligible to  participate  in the next
quarter  enrollment  period after  employment.  Participants  may make voluntary
contributions to the plan up to 15% of their compensation.  In fiscal year 2006,
2005 and 2004, the Company made  discretionary  contributions  of  approximately
$27,000,  $38,000 and $36,000,  respectively,  to match a percentage of employee
contributions.

NOTE P - SUBSEQUENT EVENT

     On June 22, 2006,  the Company  entered into an employment  agreement  with
Thomas  Glover,  President and Chief  Executive of the Company.  The  agreement,
which expires in June 2008, provides for certain benefits including a payment of
twelve months of base salary in the event of a  termination  without  cause,  as
defined, payable in twelve equal monthly installments.

                                     F - 27


<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                 Schedule II - Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
---------------------------------------- ---------------- -------------------------------- ---------------- ----------------
               Column A                     Column B                 Column C                 Column D         Column E
---------------------------------------- ---------------- -------------------------------- ---------------- ----------------
                                                                     Additions
                                                          --------------------------------
                                                                (1)             (2)
                                           Balance at       Charged to       Charged to
                                          beginning of       costs and     other accounts                   Balance at end
                                             period          expenses                        Deductions        of period
---------------------------------------- ---------------- ---------------- --------------- ---------------- ----------------
<S>                                           <C>              <C>             <C>                <C>           <C>

Allowance for doubtful accounts
  Year ended May 31, 2006                       $394,692         $110,317             $--          $94,318         $410,691
  Year ended May 31, 2005                       $699,203          $11,084             $--              (a)         $394,692
                                                                                                  $315,595
  Year ended May 31, 2004                       $768,629         $616,759             $--         $686,185         $699,203

Valuation Allowance- Financing
Receivables
  Year ended May 31, 2006                            $--              $--             $--              $--              $--
  Year ended May 31, 2005                            $--              $--             $--              $--              $--
  Year ended May 31, 2004                       $244,994         $680,000             $--              (b)              $--
                                                                                                  $924,994

Reserve for excess and obsolete
inventory
  Year ended May 31, 2006                       $566,149         $152,004             $--          $41,004         $677,149
  Year ended May 31, 2005                       $399,477         $166,672             $--              $--         $566,149
  Year ended May 31, 2004                       $280,477         $119,000             $--              $--         $399,477

Valuation Allowance - Deferred Tax
Asset
  Year ended May 31, 2006                     $3,774,000       $8,296,458      $7,489,000              $--      $19,569,458
  Year ended May 31, 2005                     $1,908,000       $1,866,000             $--              $--       $3,774,000
  Year ended May 31, 2004                       $622,000       $1,286,000             $--              $--       $1,908,000

Provision for warranty obligations
  Year ended May 31, 2006                       $118,333          $33,000             $--    (c)  $119,333          $32,000
  Year ended May 31, 2005                       $244,917          $27,000             $--              (c)         $118,333
                                                                                                  $153,584
  Year ended May 31, 2004                       $788,000         $164,000             $--    (c)  $707,083         $244,917
<FN>

     (a)  accounts receivable written off, net $10,000 in recoveries in 2005.
     (b)  financing receivables written off
     (c)  warranty claims
</FN>
</TABLE>


                                     S - 1