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, 2005

[ ]  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.
                (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 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 an  accelerated  filer (as
defined in Rule 12b-2 of the 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 $0.94 as of
November 30, 2004 was approximately $ 52,074,000. Shares of common stock held by
each  officer  and  director  and by  each  person  who  owns  5% of 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, 2005,  the number of shares  outstanding  of the  issuer's  common
stock was 58,752,688.

                      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>







                      [THIS PAGE LEFT INTENTIONALLY BLANK}

<PAGE>


                               INDEX TO FORM 10-K


                                                                        Page
                                                                        ----
                                     PART I

Item 1. Business                                                           1
        Risk Factors                                                      15
Item 2. Properties                                                        20
Item 3. Legal Proceedings                                                 20
Item 4. Submission of Matters to a Vote of Security Holders               20

                                    PART II

Item 5. Market for Registrant's Common Equity, Related
        Stockholder Matters, and Issuer Purchases of Equity Securities    21
Item 6. Selected Financial Data                                           22
Item 7. Management's Discussion and Analysis of Financial
        Condition and Results of Operations                               23
Item 7A.Quantitative and Qualitative Disclosures about Market Risk        35
Item 8. Financial Statements and Supplementary Data                       35
Item 9. Changes in and Disagreements with Accountants and
        Accounting and Financial Disclosure                               35
Item 9A.Controls and Procedures                                           35

                                    PART III

Item 10.Directors and Executive Officers of the Registrant                36
Item 11.Executive Compensation                                            36
Item 12.Security Ownership of Certain Beneficial Owners
        and Management                                                    36
Item 13.Certain Relationships and Related Transactions                    36
Item 14.Principal Accountant Fees and Services                            36

                                    PART IV

Item 15.Exhibits and Financial Statement Schedules                        37

Signatures                                                                39




<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)  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 may 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.

 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  1.4 million  lives in the United States in
2002 and was  responsible  for 1 of every 2.6 deaths,  according to The American
Heart Association (AHA) Heart and Stroke  Statistical 2005 Update (2005 Update).
Approximately  70.1 million  Americans  suffer from some form of  cardiovascular
disease. Among these, 13.0 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 are refractory to medications and
not candidates for invasive  procedures.  CHF patients are also reimbursed under
the same criteria, provided their primary symptoms are angina.

     We are also  actively  engaged  in  research  to  establish  the  potential
benefits  of EECP  therapy in the  management  of CHF and  recently  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  an  application  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  before the end of the  calendar  year.  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 angina.

                                       1
<PAGE>

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 is called ischemia.

     Typical  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. 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 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 150,000 angina patients annually who are considered refractory
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  vasodilators,  which are often  prescribed  to increase
blood flow to the  coronary  arteries.  When drugs fail or cease to correct  the
problem the patients are  considered  refractory  to medical  therapy.  Invasive
revascularization  procedures such as angioplasty and coronary stent  placement,
as well as coronary  artery bypass  grafting  (CABG) are often  employed in both
refractory and non-refractory angina patients.

     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  refractory  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
are  refractory  to medical and  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,
causing blood to back up into other organs,  especially the lungs and liver. The
condition  affects both sexes and is most common in people over age 50. Symptoms
include shortness of breath,  weakness,  fatigue,  swelling of the abdomen, legs
and ankles, rapid or irregular heartbeat,  low blood pressure and enlargement of
the liver. 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  continue to advance.  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 2005 Update, in 2002 approximately 2.4 million men and 2.5
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 35.3% from 1992 to 2002. 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. In addition to careful outpatient care and monitoring,  the economic
burden of congestive  heart  failure is enormous with an estimated  2005 cost to
the health  care system in the United  States of $27.9  billion.  In 1999,  $3.6
billion (an average of $5,456 per discharge) was paid to Medicare  providers for
CHF.

     Given the pressing need to identify new and effective methods to treat CHF,
we have been  actively  focusing  our  clinical  development  resources  on CHF.
Congestive  heart failure  offers a good  strategic fit with our current  angina
business  and offers an expanded  market  opportunity  for EECP  therapy.  Unmet

                                       2
<PAGE>

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  currently 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 trial provided  additional  clinical  evidence to demonstrate the
potential  benefits  of EECP  therapy  in the  management  of  CHF,  and we have
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 effective June 20, 2005, and CMS announced their proposed  decision memo due
date is December 20, 2005,  with an expected  National  Coverage  Analysis (NCA)
completion date of March 20, 2006;  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,  5 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.  Positive effects
have been shown in most  patients to continue for years  following a full course
of therapy.

     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   causing  the  cuffs  to  inflate   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  counter  pulse 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  under  increased  pressure.  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, to the
general benefit of the vascular  system.  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, and that more blood is forced into the coronary arteries
which supply energy to the heart muscle or myocardium.

     While the  precise  means by which EECP  therapy  achieves  its  beneficial
effects  remains  unknown,  there is evidence to suggest  that the EECP  therapy
triggers a neurohormonal  response that induces the production of growth factors
and dilates  existing  blood  vessels.  This in turn fosters the  recruitment of
collateral blood vessels,  which bypass blocked or narrowed vessels and increase
blood flow to restore  ischemic  areas of the heart muscle that are receiving an
inadequate  supply  of  blood.  The  myocardium  itself  may  also  develop  new
vasculature.  There is also evidence to support a mechanism  related to improved
function of the endothelium  (the inner lining of the blood  vessels),  reducing
constriction of blood vessels that supply  oxygenated blood to the body's organs
and tissues and 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

                                       3
<PAGE>

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  statistical  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 the
medical  literature  and support the assertion that EECP therapy is an effective
and durable treatment for patients suffering from chronic angina pectoris.

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,  showed
that  EECP  therapy  was a safe and  effective  treatment  option  for  patients
suffering from angina  pectoris,  including those on maximal  medication and for
whom invasive revascularization procedures were no longer an option. The results
of the MUST-EECP study confirmed the clinical benefits described in earlier open
trials,  namely a decline  in anginal  frequency  and a  decrease  in  exercise-
induced signs of myocardial  ischemia between EECP and sham-EECP treated groups,
and also showed a post-therapy  increase in exercise duration in the EECP group.
Data regarding  symptom relief  collected by the IEPR closely mirror the results
seen in the MUST-EECP trial.

     In fiscal 1999, we completed a  quality-of-life  study with the EECP system
in  the  same  institutions  and  with  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 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
concluded that EECP therapy increased  functional capacity of the patients,  was
beneficial to left  ventricular  function and portends to be a useful adjunct to
current medical therapy in heart failure patients.

     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

                                       4
<PAGE>

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 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 PEECH  clinical trial  enrollment was completed in February 2004,  with
187  patients.  The protocol for the study  required  patient  examinations  six
months following  treatment and evaluated changes in exercise capacity,  symptom
status and quality of life. 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 Dr. 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:

     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/min/kg  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  demonstrated  that there were  improvements in exercise duration
for  subjects  with NYHA  Class II and III  symptoms  of CHF who were given EECP
therapy as an adjunctive  therapy.  Among those treated with EECP 35.4% achieved
an exercise  duration  increase equal to or more than 60 seconds,  compared with
only 25.3% in the control  group (p = 0.016).  Peak oxygen  consumption  was not
significantly different between the two groups at six months.

     In addition,  consistent with the improvement in exercise duration, symptom
status,  assessed by the NYHA functional  class,  improved 31% in the EECP group
compared to 14% in the control group (p = 0.01) and overall  quality of life, as
reported  on the  Minnesota  Living  with Heart  Failure  scale,  also  improved
significantly.  Furthermore,  the average  increase  in  exercise  duration at 6
months was an  increase  of 25  seconds  for the  subjects  who  underwent  EECP
therapy, compared with a 10 second decline for patients without the EECP therapy
(p =  0.01).  Although  a trend  favoring  EECP  therapy  was  present  one week
following  completion of therapy,  peak oxygen consumption was not significantly
different between the two groups at six months.  Additionally,  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. Also, while the size of the study was not sufficient to assess the effect
on mortality,  no patients in the EECP-treated  group died, while there were two
deaths in the control group.  The study  concluded that the results suggest that
EECP therapy provides beneficial  adjunctive therapy in patients with NYHA Class
II-III heart failure receiving optimal pharmacological  therapy. 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 IEPR Registry

     The International EECP Patient  Registry(TM)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 5,000 patients

                                       5
<PAGE>

has been entered. Phase 2 of the IEPR, planned for an additional 2,500 patients,
began  enrollment  in  January  2002  and  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.  In
February  2003,  data points were added to assess  symptom  status and  clinical
events in patients with concomitant heart failure. The IEPR is a vital source of
information about the effectiveness of EECP therapy in a real-world  environment
for the medical  community at large. 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.  Data from the IEPR  show that  patients
continue to receive dramatic benefit at six, twelve,  twenty-four and thirty-six
months  following  completion  of their  course of EECP  therapy.  Data on 1,097
patients in the IEPR  reported  early in 2004  showed 92% of  patients  remained
alive  (including  41% free of cardiac  events during that period) and sustained
reduction in anginal status and nitrate medication use at 2 years following EECP
therapy.

The following tables illustrate the results:

<TABLE>
<CAPTION>
                            Pre-EECP       Post EECP       At 1 year       At 2 years     At 3 years
                           (N=5,019)       (N=3,982)       (N=2,374)       (N=1,022)        (N=238)
                               %               %               %               %               %
<S>                            <C>              <C>             <C>             <C>             <C>
No Angina                       --              20.7            29.1            33.3            34.9
Class I                          3.5            26.2            21.2            20.7            19.3
Class II                        14.7            36.4            29.4            26.7            24.8
Class III                       58.4            14.0            16.2            15.0            16.0
Class IV                        23.4             2.6             4.1             4.3             5.0
prn Nitro Use                   68.8            31.5            43.4            40.8            44.4

                                                                         Angina Improvement Post EECP
      Patient Demographics                   Medical History
Mean age         66.8 years       Duration of CAD       10.8 years       > 1 CCSC        82.3%
Age > 65         59.7%            Prior PCI/CABG        85.8%            > 2 CCSC        45.4%
Male gender      75.5%            Prior MI              67.6%
                                  CHF                   31.7%
                                  Diabetes              41.3%

N = number of patients reporting at these points
CCSC = Canadian Cardiovascular Society Classification
</TABLE>

Other studies and publications

     A search on the term  "external  counterpulsation"  of the PubMed  database
available    through   the    National    Library   of    Medicine    identified
one-hundred-thirty-five  (135)  citations  of articles  published in the medical
scientific  literature  since  1990,  including  22  review  articles.  The vast
majority of these  publications  have reported  results of patients with chronic
stable angina  treated with EECP therapy,  while others have reported use of the
device in other cardiovascular or non-cardiovascular indications. More recently,
articles on the use of EECP therapy in patients  with chronic heart failure have
begun to appear.

     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:

     --   Enhancement  of  coronary  and  peripheral   circulation,   myocardial
          perfusion, ventricular function and hemodynamics,
     --   Elimination or reduction of cardiac ischemia,
     --   Elimination or reduction in symptoms and improved  functional class in
          angina and heart failure,
     --   Resolution  of  reversible  ischemic  defects  found  on  quantitative
          myocardial perfusion studies,
     --   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,
     --   Elimination or reduction in use of anti-angina medications,
     --   Improved quality of life parameters in angina and heart failure.

     Moreover, several of the articles examine the potential mechanisms by which
EECP therapy causes its effects.  In summary,  they demonstrate that the therapy
can induce cardiac effects such as favorable changes in hemodynamics,  levels of
circulating  neurohormones,  endothelial and vascular function, blood supply and
tissue  perfusion,  as well  as  peripheral  effects  in the  form  of  "passive
exercise" and peripheral conditioning.  They also introduce the possibility that
the effects of EECP therapy result from a multifactorial process.

                                       6
<PAGE>

Strategic Initiatives

     Our short- and long-term plans are to:

     a)   Increase the domestic reimbursable user base for the EECP therapy by:

          i)   expanding  reimbursement to include coverage for the treatment of
               NYHA Class II and III CHF patients with an ejection fraction less
               than 35% on optimal medical therapy,
          ii)  marketing directly to third-party payers to increase  third-party
               reimbursement, and
          iii) expanding  reimbursement coverage in the refractory angina market
               to include patients with CCS Class II angina.

     b)   Increase the clinical and scientific understanding of the EECP therapy
          by:

          i)   completing the analysis of the PEECH clinical  trial,  publishing
               the  results  in  a  major  peer-reviewed   medical  journal  and
               submitting 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
          iii) providing  an  ongoing  grant to fund the Phase II portion of the
               International   EECP  Patient   Registry  at  the  University  of
               Pittsburgh  Graduate  School of Public  Health to  publicize  key
               information relating to patient outcomes.

     c)   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.

     d)   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.

     e)   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.

     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.  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 in the United  States
through a direct  sales force  directly  to  hospitals,  clinics  and  physician
private  practices.  Our sales force is  currently  comprised  of  approximately
fifteen sales  representatives  and is supported by a management team consisting
of a vice  president  of  sales,  two  regional  sales  managers  plus  in-house
administrative support.

     The  efforts  of  our  sales   organization  are  further  supported  by  a
field-based  staff of six 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
and  increase  awareness of EECP  therapy in the medical  community.  Additional
marketing  activities include creating awareness among third-party payers to the
benefits  of the  EECP  treatment  for  patients  suffering  from CHF as well as
angina.

                                       7
<PAGE>

     We employ  six field  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 as required. 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  confirmation clinical trials,  conducted by local key opinion leaders
in cardiology,  required to obtain Ministry of Health approval or certification.
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, including clinical training and product maintenance services.

     To date,  revenues from international  operations have not been significant
(fiscal 2004 revenues were less than 5% of total  revenues)  however,  in fiscal
year 2005  international  sales revenue  exceeded 9% and we anticipate  revenues
from  international  operations to increase in future years.  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  three  direct  competitors  with an
external  counterpulsation  device on the  market,  namely  Cardiomedics,  Inc.,
Nicore,  Inc.  and Living Data  Technologies.  In  addition,  at least six 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,  and nesiritide
(Natrecor(R));  as well as newer technologies currently in FDA-approved clinical
trials  such as spinal  cord  stimulation  (SCS).  We are  unaware  of any other
biotech or pharmaceutical technologies that may impact our ability to market and
distribute EECP therapy systems in the near term.

     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.

                                       8
<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. 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
patent-pending 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.

Premarket Review

     The 510(k) premarket  notification process requires an applicant to give 90
days 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 we
must receive an order from the FDA  classifying  the device under section 510(k)

                                       9
<PAGE>
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).  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.
                                       10
<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 Conformity
Assessment System (CMDCAS).

     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.

     The "ACC/AHA  2002  Guideline  Update for the  Management  of Patients with
Chronic  Stable  Angina"  were  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".  These  guidelines  are not  expected  to be updated for some
time.

     The ACC/AHA  Guidelines  for the Evaluation and Management of Chronic Heart
Failure  in  the  Adult  were  last   issued  in  2001.   Comments  on  external
counterpulsation  appear in a section  entitled "Drugs and  Interventions  Under
Active   Investigation"  and  include  the  statement  "[u]ntil  more  data  are
available,  this approach  cannot be recommended  for the management of patients
with symptomatic left ventricular  systolic  dysfunction".  A revised version of
these guidelines have been under  development for some time and may be issued in
the  relatively  near  future.  However,  we do not believe  they will include a
substantive   change   in  the   recommendation   regarding   use  of   external
counterpulsation  in chronic heart failure in adults  because the results of the
PEECH trial have not yet appeared in a peer-reviewed publication. Other evidence
that has appeared in  peer-reviewed  publications  since issuance of the current

                                       11
<PAGE>

guidelines  includes  results of a pilot study in heart  failure and analyses of
patients  with angina  complicated  by left  ventricular  dysfunction  that were
enrolled in the International  Patient Registry.  However,  such studies,  while
valued in  certain  respects,  are not  considered  as strong as the  results of
randomized, controlled clinical trials in assessing the strength of evidence for
or against a particular  procedure or therapy.

     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.

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  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  administrated  by the
Centers for Medicare and Medicaid  Services  (CMS),  and 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 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:  obtaining  Medicare  coverage for congestive  heart  failure,  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:

                                       12
<PAGE>

     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."

     Additionally,  a  physician  must  be  present  in  the  office  suite  and
immediately  available to provide assistance and directions  throughout the time
that personnel are performing the procedure.

     The 2005 national  average payment rate per hourly session in the physician
office setting and the hospital  outpatient  facility is approximately  $138 and
$102,  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.
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  34% to the 2004 rate, while the average payment rate for
the hospital  outpatient  facility declined steadily to the 2004 rate.  Although
CMS proposed a further reduction in physician fees for the EECP therapy in 2005,
this was  successfully  negotiated  to reflect an increase of 1.2% over the 2004
rate, reversing the declining trend.

     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  proposed  decision  memo due date is
December 20, 2005, with an expected  National Coverage Analysis (NCA) completion
date of 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 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:

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

     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 would
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.

                                       13
<PAGE>

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
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 nine US patents  including six 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 eight major U.S.  applications pending for approval,  relating to aspects of
the TS3  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", as well as for its widely-recognized man-like
figure representing the application of EECP therapy.

     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 our
technical  leadership is demonstrated by the number of patents and applications,
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
and we believe that none has more than one patent application pending.

     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, 2005, we employed 76 full-time  and 2 part-time  persons with
21 in  direct  sales  and  sales  support,  6 in  clinical  applications,  25 in
manufacturing,  quality  control  and  technical  service,  6 in  marketing  and
customer support,  9 in engineering,  regulatory and clinical research and 11 in
administration.  None of our  employees  are  represented  by a labor union.  We
believe that our employee relations are good.

                                       14
<PAGE>

     In March  2004,  the then  current  Chief  Executive  Officer  (CEO) of the
Company resigned from the Company,  and Photios T. Paulson accepted the position
as acting CEO and served from March to October 2004 at which time Thomas  Glover
was appointed President and Chief Executive Officer of the Company.

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
standard  with  specific  requirements  consistent  with the FDA Quality  System
Regulation.  While  previously  we  were  certified  to  comply  with  ISO  9001
requirements,  we 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 Conformity Assessment System (CMDCAS).

     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.

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 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.  While we have been engaged in discussions  with the Centers
for  Medicare and  Medicaid  Services to expand the class of heart  patients for
medical coverage,  we are uncertain as to the outcome of these meetings. We also
have been engaged in certain  clinical  trials for the purpose of expanding this
coverage,  most  notable  being our PEECH  clinical  trial.  Our  business  plan
projects  that the  results  could  substantially  expand the number of patients
available  for  medical  reimbursement.  However  Medicare,  Medicaid  and other
third-party payers may deny expansion of reimbursement coverage if they feel the
data from the PEECH clinical trial and other clinical  studies is not sufficient
to  support a  positive  coverage  decision.  On May 31,  2005 we  submitted  an
application to CMS to expand the national  coverage policy for EECP treatment to
include, among other patients,  patients with congestive heart failure (CHF). 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

                                       15
<PAGE>

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
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 cost-effective,  is experimental or is used for an unapproved indication.
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 three 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.

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

                                       16
<PAGE>

     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 recordkeeping. 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 may not be able to manage growth.

     If our short and  long-term  plans are  successful,  including our clinical
trials,  we will  experience  a period of growth that could place a  significant
strain  upon  our   managerial,   financial  and  operational   resources.   Our
infrastructure, procedures, controls and information systems may not be adequate
to support  our  operations  and to achieve  the rapid  execution  necessary  to
successfully market our products.  Our future operating results will also depend
on our ability to  successfully  upgrade  our  information  systems,  expand our
direct sales force and our internal  sales,  marketing and support staff.  If we
are unable to manage future  expansion  effectively,  our  business,  results of
operations and financial  condition will suffer,  our senior  management will be
less effective, and our revenues and product development efforts may decrease.

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

                                       17
<PAGE>

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.

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.

                                       18
<PAGE>

Risks Related to Stock Exchange and SEC Regulation

A continued  stock price below $1 could result in our being  de-listed  from the
Nasdaq and  subject us to  regulations  that could  reduce our  ability to raise
funds.

     By letter dated May 2, 2005, the Company received written notification from
Nasdaq  that  the bid  price of its  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),  the Company has been  provided an initial
period of 180 calendar days of until October 31, 2005, to regain compliance.  If
at any time before that date the bid price of the Company's  common stock closes
at $1.00 per share or more for a minimum of 10  consecutive  business  days, the
Company will be provided written  notification that it is in compliance with the
Rule.

     Further,  if the Company is not in compliance  with the Rule by October 31,
2005, and the Company meets the Nasdaq SmallCap  initial listing criteria except
for the bid price  requirement,  it will be granted an  additional  180 calendar
days to April 29, 2006 to comply.  In this regard,  the Company  currently meets
all of the initial listing criteria except for the bid price requirement.

     Nasdaq's  notification  further provides that in the event the Company were
to  receive  written  notification  that its  securities  will be  delisted,  it
maintains  its right to appeal such  determination  to a Listing  Qualifications
Panel.

     Ultimately,  non-compliance  could result in Nasdaq delisting the Company's
common stock.  Such  delisting  could have an adverse effect on the liquidity of
the Company's common stock and could also impact the Company's  ability to raise
additional equity capital, if necessary.

     In the event that our common stock was de-listed  from the Nasdaq  SmallCap
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.

     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.

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 has been and is likely to continue to
be highly  volatile.  Our stock price could be subject to wide  fluctuations  in
response to various factors beyond our control, including:

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

                                       19
<PAGE>

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.

Recent corporate  scandals  involving  alleged  accounting  irregularities  have
resulted in  unavailability  of, or significantly  higher premiums for, director
and officer liability insurance.

     As a result of recent  well-publicized  corporate business failures alleged
to have  involved  improper acts by executives  and  accounting  irregularities,
director and officer liability insurance has become more difficult to obtain and
the premiums for such insurance have increased  significantly.  If we are unable
to obtain director and officer liability  insurance at rates that are reasonable
or at all, we may not be able to retain our current  officers  and  directors or
attract qualified directors and officers in the future.

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 lease approximately 7,100 square
feet  of   additional   warehouse   space  under  two   operating   leases  with
non-affiliated landlords, of which one expires in October 2005, and the other in
September 2006, plus additional  parking locations in the area at an annual cost
of approximately $92,000. We believe that we can renegotiate the lease that will
expire in October 2005, or lease other  available space under  reasonable  terms
and that these  combined  facilities  are 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.

                                       20
<PAGE>

     PART II

ITEM 5 -  MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY
          HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     Our common  stock trades on the Nasdaq  SmallCap  Market tier of The Nasdaq
Stock  Market(SM)  under the symbol VASO. The number of record holders of common
stock as of August 1, 2004,  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 as reported by the Nasdaq SmallCap Market tier of The
Nasdaq Stock Market(SM) for the fiscal periods specified.

<TABLE>
<CAPTION>

                               Fiscal 2005                Fiscal 2004
                            High          Low          High           Low
<S>                         <C>          <C>           <C>           <C>
First Quarter               $1.27        $0.83         $1.55         $0.84
Second Quarter              $1.25        $0.90         $1.59         $0.86
Third Quarter               $1.52        $0.90         $2.34         $1.00
Fourth Quarter              $1.98        $0.57         $1.94         $1.10
</TABLE>

     The last bid price of the  Company's  common  stock on August 1, 2005,  was
$0.61 per share.

Notice of Failure to Satisfy a Continued Listing Rule

     By letter dated May 2, 2005, the Company received written notification from
Nasdaq  that  the bid  price of its  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),  the Company has been  provided an initial
period of 180 calendar days of until October 31, 2005, to regain compliance.  If
at any time before that date the bid price of the Company's  common stock closes
at $1.00 per share or more for a minimum of 10  consecutive  business  days, the
Company will be provided written  notification that it is in compliance with the
Rule.

     Further,  if the Company is not in compliance  with the Rule by October 31,
2005, and the Company meets the Nasdaq SmallCap  initial listing criteria except
for the bid price  requirement,  it will be granted an  additional  180 calendar
days to April 29, 2006, to comply.  In this regard,  the Company currently meets
all of the initial listing criteria except for the bid price requirement.

     Nasdaq's  notification  further provides that in the event the Company were
to  receive  written  notification  that its  securities  will be  delisted,  it
maintains  its right to appeal such  determination  to a Listing  Qualifications
Panel.

     Ultimately,  non-compliance  could result in Nasdaq delisting the Company's
common stock.  Such  delisting  could have an adverse effect on the liquidity of
the Company's common stock and could also impact the Company's  ability to raise
additional equity capital, if necessary.

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.

Recent Sales of Unregistered Securities.

     On July 19, 2005, we entered into a Securities Purchase Agreement that will
provide 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").  We received  $1.75 million or 70% of the gross  proceeds on
July 19, 2005 and the  balance of  $750,000 is expected to be received  upon the
filing of the registration  statement (see below).  The agreement provides for a
private  placement of 25,000 shares of our Series D Preferred  Stock at $100 per
share.  By the placement of the preferred  stock,  we became  obligated to pay a
cash dividend monthly on the outstanding shares of 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.

                                       21
<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,
                                                         2005           2004            2003           2002            2001
Statements of Earnings
<S>                                               <C>            <C>             <C>            <C>             <C>
Revenues                                          $15,095,778    $22,207,037     $24,823,619    $34,830,471     $27,508,338
Cost of sales and services                          5,504,535      7,590,103       9,251,221     10,538,731       7,910,359
                                                -------------- -------------- --------------- -------------- ---------------
   Gross profit                                     9,591,243     14,616,934      15,572,398     24,291,740      19,597,979

Selling, general & administrative expenses         12,006,774     12,910,997      13,714,913     13,686,958      11,634,965
Research and development expenses                   3,064,683      3,748,389       4,544,822      5,112,258       2,554,470
Provision for doubtful accounts                        11,084      1,296,759       3,728,484      1,304,000         325,000
Interest and financing costs                          105,232        132,062         186,574         98,140          48,294
Interest and other income, net                        (74,153)       (99,393)       (176,724)      (249,722)       (201,992)
                                                -------------- -------------- --------------- -------------- ---------------
                                                   15,113,620     17,988,814      21,998,069     19,951,634      14,360,737
                                                -------------- -------------- --------------- -------------- ---------------
Earnings (loss) before income taxes                (5,522,377)    (3,371,880)     (6,425,671)     4,340,106       5,237,242

Income tax (expense) benefit, net                     (39,661)       (50,640)      1,634,688     (1,554,000)      6,457,108
                                                -------------- -------------- --------------- -------------- ---------------
 Net earnings (loss)                             $ (5,562,038)   $(3,422,520)    $(4,790,983)    $2,786,106     $11,694,350
                                                ============== ============== =============== ============== ===============

Net earnings (loss) per common share
    - basic                                            $(0.10)        $(0.06)         $(0.08)         $0.05           $0.21
                                                ============== ============== =============== ============== ===============
    - diluted                                          $(0.10)        $(0.06)         $(0.08)         $0.05           $0.20
                                                ============== ============== =============== ============== ===============
Weighted average common shares
  outstanding - basic                              58,547,574     57,981,963      57,647,032     57,251,035      56,571,402
                                                ============== ============== =============== ============== ===============
              - diluted                            58,547,574     57,981,963      57,647,032     59,468,092      59,927,199
                                                ============== ============== =============== ============== ===============
Balance Sheet Data
Cash, cash equivalents, and certificates of
   deposit                                         $2,747,967     $7,545,589      $5,222,847     $2,967,627      $3,785,456
Working capital                                    $3,932,769     $9,771,870     $11,478,092    $17,225,434     $16,214,655
Total assets                                      $25,361,470    $33,023,615     $35,327,550    $41,418,258     $36,518,974
Long-term debt                                       $947,597     $1,092,837      $1,177,804     $1,072,716      $1,108,593
Stockholders' equity (1)                          $19,162,797    $24,594,169     $27,319,302    $31,602,604     $28,508,729
___________________
(1) No cash dividends on common stock were declared during any of the above periods.
</TABLE>

                                       22
<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 the dramatic changes taking place in the healthcare  environment;  the
impact of medical insurance reimbursement  policies;  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.  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 may restore systemic vascular
function.  We  provide  hospitals  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 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 are refractory to medications and
not candidates for invasive  procedures.  CHF patients are also reimbursed under
the same criteria, provided their primary symptoms are angina.

     We are also  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),  is 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 before the end of the calendar year. On
May 31,  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, as well as additional patients with angina.

Results of Operations

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.

                                       23
<PAGE>
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  earned a 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.

     We believe the decline in domestic units shipped  reflects  weakened demand
in the  refractory  angina market as existing  capacity is more fully  utilized,
coupled with increased  competition from surgical procedures,  mainly the use of
drug-eluting stents. We anticipate that demand for EECP systems will remain soft
until a projected expansion of the current CMS national reimbursement policy for
use of EECP therapy to treat congestive  heart failure patients is obtained.  If
we are  unable to obtain an  adequate  national  Medicare  coverage  policy  for
treatment  procedures  using the EECP therapy system in CHF, it would  adversely
affect our business  prospects.  In addition,  average  domestic  selling prices
continue  to  decline  reflecting  the  impact  in the  market  of lower  priced
competitive  products.  We continue to believe that our EECP  systems  currently
sell at a  significant  price premium to  competitive  products  reflecting  the
clinical  efficacy and superior quality of the EECP therapy system plus the many
value added services  offered by us.  However,  we anticipate  that this current
trend  of  declining  prices  will  continue  in  the  immediate  future  as our
competition  attempts to capture greater market share through pricing discounts.
In addition,  we sold an unusually  high  percentage  of used  equipment,  which
reflected the  availability  of used EECP systems that had been recovered from a
former customer, as well as EECP systems that had been used to treat patients in
the PEECH  clinical  trial but were no longer  required since the trial has been
completed.  These used systems were sold at average  sales prices  significantly
below our new  systems.  We sell used  equipment as available to help lessen the
impact of price sensitive situations.  Lastly, we continue to reorganize certain
territory  responsibilities  in  our  sales  department  due  to  vacant  and/or
unproductive  territories,  completed the  restructuring of a major  independent
distributor  territory  to  direct  sales,  and  reduced  the  number  of  sales
territories to 15 from 21.

     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 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.  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

                                       24
<PAGE>

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
operating expenses and other costs 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.

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 years  ended May 31,  2005,  and May 31,  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 amount of the deferred tax assets considered realizable
could be reduced in the future if estimates of future  taxable income during the
carryforward period are reduced. Ultimate realization of the deferred tax assets

                                       25
<PAGE>

is  dependent  upon  our  generating  sufficient  taxable  income  prior  to the
expiration  of the tax  loss  carryforwards.  We  believe  that the  Company  is
positioned  for  long-term  growth  despite the losses during fiscal years 2005,
2004 and 2003, and that based upon the weight of available evidence,  that it is
"more likely than not" that net deferred tax assets will be realized.  The "more
likely than not" standard is subjective, and is based upon management's estimate
of a greater  than 50%  probability  that its long  range  business  plan can be
realized.

     Ultimate  realization  of any or all of  the  deferred  tax  assets  is not
assured, due to significant  uncertainties and material  assumptions  associated
with  estimates of future  taxable income during the  carryforward  period.  Our
estimates are largely  dependent upon achieving  considerable  growth in revenue
and profits resulting from the successful commercialization of EECP therapy into
the  congestive  heart  failure  indication,  which we believe will enable us to
reverse the current trend of increasing  losses and generate  pre-tax  income in
excess of $39 million over the next seven years in order to fully utilize all of
the deferred tax assets.  Such  estimates of future  taxable income are based on
our beliefs, as well as assumptions made by and information  currently available
to us. Certain critical assumptions associated with our estimates include:

     --   that the results from the PEECH clinical  trial, as disclosed in "Item
          1 - Business" of this Form 10K, as well as other clinical evidence are
          sufficiently  positive for the PEECH clinical trial to be published in
          a peer-reviewed  journal and to enable EECP therapy to obtain approval
          of a  national  Medicare  reimbursement  coverage  policy  plus  other
          third-party payer  reimbursement  policies inclusive of the congestive
          heart failure indication;
     --   that the reimbursement  coverage will be both broad enough in terms of
          coverage  language  and at an amount  adequate  to  enable  successful
          commercialization  of EECP therapy into the  congestive  heart failure
          indication  and enable us to achieve  material  growth in revenue  and
          profits;
     --   that  EECP  therapy  will  be  sufficiently  accepted  by the  medical
          community  as an  adjunctive  therapy  for the  treatment  of patients
          suffering from congestive heart failure; and
     --   that  we  will  be able to  secure  additional  financing  to  provide
          sufficient  funds to  market  EECP  therapy  in the  congestive  heart
          failure indication.

     Additional   uncertainties  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;
     --   other medical insurance reimbursement policies;
     --   there  can be no  assurance  that we will be able to raise  additional
          capital necessary to implement our business plan;
     --   unexpected manufacturing problems;
     --   unforeseen  difficulties and delays in the conduct of clinical trials,
          peer-reviewed publications and 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;
     --   our recent financial history of declining revenues and losses; and
     --   the risk factors reported from time to time in our SEC reports.

     Factors  considered  by us in making our  assumptions  and  included in our
long-term business plan are the following:

     --   we currently  have FDA  clearance to market EECP therapy in congestive
          heart failure;
     --   independent  market  research  indicates  that the patient  population
          potentially  eligible for EECP  therapy in  congestive  heart  failure
          market is larger than the current refractory angina patient population
          and when the two patient  populations  are  combined  the total market
          opportunity for EECP therapy will be more than double;
     --   many  physician  practices  have  told  us  that  they  do not  have a
          sufficient number of patients to economically  justify adoption of the
          procedure  with the  current  reimbursement  coverage  for  refractory
          angina.  The increased  market size resulting from the addition of CHF
          patients could improve the economic model for the physician practice;
     --   we have positive  clinical evidence from the PEECH clinical trial that
          was recently  concluded,  plus other smaller  clinical  trials and the
          IEPR patient registry that demonstrates the clinical  effectiveness of
          EECP therapy in the treatment of  congestive  heart failure to medical
          providers, payers and regulators;

                                       26
<PAGE>

     --   we completed the PEECH  clinical trial this fiscal year as planned and
          disclosed the summary results of the trial in March 2005;

     --   we  intend  to have the  results  of the PEECH  trial  published  in a
          peer-reviewed journal, which is an important step necessary to support
          an application to CMS to expand reimbursement coverage of EECP therapy
          to include CHF patients;

     --   we sustained a period of  profitability in fiscal years 2000, 2001 and
          2002 with profits  before income taxes of  $1,290,916,  $5,237,242 and
          $4,240,106, respectively; and

     --   we continue to believe that we will be able to raise  sufficient funds
          to enable us to execute our business plan.

     While we believe that we will be able to execute our business plan over the
longer term and we will be able to utilize our tax loss carryforwards, the exact
timing of our return to  profitability  is  uncertain,  subject  to  significant
management  judgments  and  estimates  and  dependent  on a variety of  external
factors including: market conditions at that time, the reception of EECP therapy
by medical  professionals and payers and the timing of a Medicare  reimbursement
decision.  It is possible that  significant tax loss  carryforwards  from fiscal
years 2005, 2006 and 2007 may expire before we are able to use them. As a result
of these  uncertainties,  beginning  in  fiscal  2004,  we began  to  provide  a
valuation reserve for all additional tax loss  carryforwards that were generated
by current  operating  losses.  We review this  policy on a quarterly  basis and
believe  that the above  valuation  reserve  is  appropriate  under the  current
circumstances.

     The  amount of the  deferred  tax  assets  considered  realizable  could be
reduced  in the  future  if  estimates  of  future  taxable  income  during  the
carryforward period are reduced.

     The recorded  deferred tax asset and  increase to the  valuation  allowance
during the year ended May 31,  2005 and 2004,  was  $1,866,000  and  $1,286,000,
respectively.

Fiscal Years Ended May 31, 2004 and 2003

Summary

     We generated  revenues from the sale, lease and service of our EECP systems
of  $22,207,037  and  $24,823,619  for the years  ended  May 31,  2004 and 2003,
respectively, reflecting a decrease of $2,616,582 or 11%. Our loss before income
taxes was  $3,371,880  and $6,425,671 for the years ended May 31, 2004 and 2003,
respectively.  We reported a net loss of $3,422,520 and $4,790,983 for the years
ended May 31, 2004 and 2003, respectively.

Revenues

     The decline in revenues in fiscal year 2004 compared to fiscal year 2003 is
due  primarily to lower  revenue  from the sale of EECP  therapy  systems in the
domestic   market.   Domestic   equipment   revenue  for  fiscal  2004  declined
approximately  15%  compared  to prior year due to: a  reduction  in the average
sales price for EECP therapy systems of approximately  12%; a higher  proportion
of used  equipment  compared  to new  equipment  sold  during  fiscal  year 2004
compared to 2003,  plus  adoption of the  provisions  of EITF 00-21.  Revenue in
fiscal year 2004 reflects a 115%  increase in the sale of used  equipment to the
domestic  market.  This increase in used equipment  sales reflects  primarily an
increase in used  equipment  available for sale  following the completion of the
PEECH trial and the repossession of EECP systems from previous  sales-type lease
customers.  In September 2003, we adopted  "Revenue  Arrangements  with Multiple
Deliverables",  ("EITF 00-21"). During the nine months following adoption of the
provisions  of EITF 00-21,  as a result of the  adoption  of the new policy,  we
deferred  $92,500 of  revenue  related  to the fair  value of  installation  and
in-service  training and $658,333 of revenue related to the warranty service for
EECP system sales, which would have previously been recognized as revenue during
the period.  International  shipments of EECP systems declined approximately 24%
to $850,333 due to a higher sales rate in the previous year following receipt of
the CE Mark.  This was  partially  offset  by a 47%  increase  in  revenue  from
equipment  rental and services  reflecting an increase of  approximately  94% in
service  related  revenue.  The higher service  revenue  reflects an increase in
service,  spare parts and consumables as a result of the continued growth of the
installed  base of EECP  systems  and  greater  marketing  focus  on the sale of
extended service contracts. Rental revenue declined approximately 27% during the
period reflecting fewer  outstanding  rental agreements and lower average rental
prices.

Gross Profit

     Gross profit was  $14,616,934 or 66% of revenues for the year ended May 31,
2004,  compared to  $15,572,398  or 63% of  revenues  for the year ended May 31,
2003. Gross profit margin as a percentage of revenue for the twelve-month period

                                       27
<PAGE>

ended May 31, 2004,  improved compared to the same year of the prior fiscal year
despite the lower revenue and the impact from the  reduction in average  selling
prices.  The  improvement  in gross profit as a percentage of sales reflects the
decline in expenditures for service related parts,  travel and personnel for the
year ended May 31,  2004,  when  compared to same  period of the prior year.  In
addition,  the gross profit margin  benefited from the sale of an unusually high
percentage  of used  equipment  when  compared to the prior year.  These systems
carried  lower book values since they were  partially  amortized and as a result
generated  above average  margins.  The decline in gross profit when compared to
the prior year in absolute dollars is a direct result of the lower sales volume.

Selling, General and Administrative

     Selling,  general and  administrative  ("SG&A") expenses for the year ended
May 31,  2004 and 2003  were  $12,910,997  or 58% of  revenues  as  compared  to
$13,714,913  or 55% of revenues,  respectively.  The  decrease of SG&A  resulted
primarily  from a  one-time  $600,000  charge  arising  from the  settlement  of
litigation in the prior year plus a severance charge for approximately  $300,000
in the  prior  year,  as well as lower  marketing  expenditures,  primarily  for
outside services and promotional  spending for print and electronic media during
fiscal year 2004,  as compared to fiscal  year 2003.  The above  decreases  were
partially offset by higher administrative and selling expenses,  which reflected
increased  insurance  costs and continued  investment in our direct sales force,
consisting of additional personnel and higher incentive and travel costs.

Research and Development

     Research and development  ("R&D") expenses of $3,748,389 or 17% of revenues
for fiscal  year 2004,  decreased  by  $796,433,  or 18%,  from fiscal year 2003
expenses of  $4,544,822,  or 18% of revenues.  The decrease is due  primarily to
reduced clinical study expenditures related to the completion of several smaller
clinical studies and, at several sites, the patient treatment phase of the PEECH
study. This decrease was partially offset by increased product development costs
related to new EECP system models and improvements.

Provision for Doubtful Accounts

     During the year ended May 31, 2004, we charged  $1,296,759 to our provision
for doubtful  accounts as compared to  $3,728,484  during the year ended May 31,
2003. In fiscal 2004,  these charges reflect  management  decision in the second
quarter  of fiscal  2004 to record a $680,000  provision  to the  allowance  for
doubtful  accounts,  which  represents  all  funds due from a  sales-type  lease
customer.  We sold our EECP systems to a major customer  engaged in establishing
independent  networks  of  EECP  treatment  centers  under  a  sales-type  lease
aggregating  revenues of  $1,271,888.  No additional  equipment was sold to this
customer  during  fiscal 2003 or 2004.  This customer  became  delinquent in its
scheduled  monthly payments during the fourth quarter of fiscal 2003. During the
first and second  quarters of fiscal 2004 the  customer  attempted to remedy the
situation  and made  payments to us totaling  $70,000.  In  December  2003,  the
customer ceased operations.  Additional provisions for all other accounts totals
approximately  $616,759.  In fiscal 2003, these charges primarily  resulted from
approximately  a $3.0 million  write-off of receivables  with respect to another
major customer,  comprised of $2.5 million for the capital lease and $500,000 in
notes  receivable,  as well as specific  reserves against certain  international
accounts for which extended credit terms were offered.

Interest Expense and Financing Costs

     Interest  expense and  financing  costs  decreased  to $132,062 in the year
ended May 31, 2004,  from  $186,574 for the same period in the prior year due to
repayment of our revolving  secured credit facility in May 2003,  which resulted
in lower average outstanding borrowings during the fiscal year.

Interest and Other Income, Net

     Interest  income and other income for the years ended May 31, 2004, and May
31 2003, was $99,393 and $176,724, respectively. The decrease in interest 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
2003, as well as declining interest rates this year over last year earned on the
average cash  balances.  Higher average cash balances  invested  during the year
ended May 31, 2004, compared to the prior period partially offset the above.

                                       28
<PAGE>

Income Tax (Expense) Benefit, Net

     During the fiscal year ended May 31,  2004,  we  recorded a  provision  for
state income  taxes of $50,640.  This is in contrast to an income tax benefit of
$1,634,688 reported during the fiscal year ended May 31, 2003.

     As of May 31, 2004, we had recorded  deferred tax assets of $14,582,000 net
of a $1,908,000  valuation allowance related to the anticipated  recovery of tax
loss carryforwards.

     The recorded  deferred tax asset and  increase to the  valuation  allowance
during the fiscal year ended May 31, 2004 was $1,286,000.

Liquidity and Capital Resources

Cash and Cash Flow

     We have  financed our  operations  in fiscal 2005 and 2004  primarily  from
operations  and  working  capital.  At  May  31,  2005,  we  had  a  cash,  cash
equivalents,  and  certificates  of deposit  balance of  $2,747,967  and working
capital of $3,932,769  as compared to a cash balance of  $7,545,589  and working
capital  of  $9,771,870  at May  31,  2004.  Our  cash,  cash  equivalents,  and
certificates  of  deposit  balances  decreased  $4,797,622  in fiscal  year 2005
primarily due to the net loss of $5,562,038.

     The  decrease  in  cash  used by our  operating  activities  of  $4,594,584
resulted  primarily from the net loss of $5,562,038  plus increases in inventory
of  $1,295,294,  decreases  in  accounts  payable  and  accrued  liabilities  of
$1,662,193 and decreases in other long term  liabilities of $435,074.  The above
was partially  offset by reduced  accounts  receivable,  which  provided cash of
$3,618,767.  Net  accounts  receivable  were 50% of  quarterly  revenues for the
three-  month  period  ended  May 31,  2005,  compared  to 93% at the end of the
three-month  period ended May 31, 2004,  and net  accounts  receivable  turnover
improved to 4.1 times as of May 31, 2005, as compared to 3.4 times as of May 31,
2004. We have tightened our sales credit policy,  reduced extended payment terms
and provide routine oversight with respect to our accounts receivable credit and
collection efforts.

     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 competitive situations,  when opening new
markets or geographies or 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 fiscal years
ended May 31, 2005 and 2004, approximately 3% and 1% of revenues,  respectively,
were  generated  from sales in which 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.

     Non-cash adjustments for depreciation, amortization, allowance for doubtful
accounts and  allowance  for  inventory  write-offs to reconcile the net loss of
$5,562,038 to net cash provided by operating activities total $756,286.

     Investing activities used net cash of $778,101 during the fiscal year ended
May 31, 2005,  reflecting  investment associated with the purchase of short-term
certificates of deposit and treasury bills of $ $3,747,903 offset by redemptions
of $3,170,000, and the purchase of property and equipment of $200,198.

     Financing  activities  used net cash of $2,840 during the fiscal year ended
May 31,  2005,  reflecting  payments of principal on notes and loans of $133,506
partially  offset by $130,666  received form the exercise of stock  options.

     We cancelled our line of credit in August 2004 and do not currently 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 will
provide 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").  We received  $1.75 million or 70% of the gross  proceeds on
July 19, 2005 and the  balance of  $750,000 is expected to be received  upon the
filing of the registration  statement (see below).  The agreement provides for a

                                       29
<PAGE>

private placement of 25,000 shares of Vasomedical's  Series D Preferred Stock at
$100 per share.  The preferred stock is 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  registering  the shares of common  stock that
could be acquired through  conversion of the preferred shares,  Vasomedical may,
at its option,  require the  holders to convert all their  preferred  stock into
common  shares if the market  price for the common  stock for the  preceding  20
trading days has been $1.30 or more per share.  Such a conversion by Vasomedical
is not  allowed if it would make the stock held by the  Investors  through  this
transaction and the conversion exceed 9.99% of the common stock outstanding. 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 $0.6936 per share for a term
of five years,  ending July 18, 2010.  Under the terms of a Registration  Rights
Agreement  with the Investors,  Vasomedical is to file a registration  statement
with the Securities and Exchange Commission by September 2, 2005, for the shares
of common stock underlying the preferred stock and the warrants.

     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 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.

     An event of default occurs if Vasomedical fails to timely pay the dividend,
fails to timely file a  registration  statement  for the shares of common  stock
underlying  the  preferred  shares  and  the  warrants,   or  has  not  obtained
effectiveness  of the  registration  statement by December 1, 2005,  among other
specified  occurrences.  Upon an  event of  default,  the  price  at  which  the
preferred stock may be converted into common stock is reduced from 85 percent to
75 percent of the then current volume  weighted  average market price per share,
but not more than $0.6606 or less than $0.30 per share. In addition, the holders
of the  preferred  stock  have the  right to be paid  first  from the  assets of
Vasomedical  upon  any  dissolution  or  liquidation  of  the  company.  If  the
registration  statement  is  not  timely  filed  or  declared  effective  by the
Securities and Exchange  Commission,  Vasomedical is to pay the Investors $1,467
in cash for each day of delay.

     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 believe  that our cash flow from  operations  together  with our current
cash reserves and the cash received for the sale of convertible  preferred stock
and warrants on July 19, 2005,  will be sufficient to fund our business plan and
projected capital  requirements  through at least May 31, 2006. However, we have
incurred significant losses during the last three fiscal years and our long-term
ability to maintain  current  operations is dependent upon achieving  profitable
operations,  which is largely dependent upon the successful commercialization of
EECP therapy into the congestive heart failure  indication,  and depends in part
upon the  acceptance of the results of the PEECH  clinical  trial by the medical
community and expanded reimbursement coverage to include CHF as being sufficient
to promote the  adoption of EECP therapy in CHF; or through  additional  debt or
equity financing.  In the event that additional capital is required, we may seek
to raise  such  capital  through  public or private  equity or debt  financings.
Future  capital  funding,  if  available,  may  result in  dilution  to  current
shareholders.

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,  2005,  we are not  involved  in any
unconsolidated SPE.

                                       30
<PAGE>

Contractual Obligations

     The following table presents our expected cash requirements for contractual
obligations outstanding as of May 31, 2005:

<TABLE>
<CAPTION>
                                                                         Due as of       Due as of
                                                          Due as of     5/31/07 and     5/31/09 and          Due
                                         Total             5/31/06        5/31/08         5/31/10        Thereafter
--------------------------------------------------------------------------------------------------------------------
<S>                                    <C>                <C>             <C>             <C>              <C>
Long-Term Debt                         $1,095,809         $148,212        $162,351        $146,153         $639,093
Operating Leases                           76,567           62,329          14,238              --               --
Litigation Settlement                     200,750          133,250          67,500              --               --
Employment Agreements                      40,625           40,625              --              --               --
--------------------------------------------------------------------------------------------------------------------
Total Contractual Cash                 $1,413,751         $384,416        $244,089        $146,153         $639,093
Obligations
====================================================================================================================
</TABLE>

     By the placement of the  convertible  preferred  stock on July 19, 2005, as
described  in above,  we  became  obligated  to pay a  dividend  monthly  on the
outstanding  shares of 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. The dividend is payable in cash.

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 A of  the  Notes  to  Consolidated
Financial  Statements  included  in our Annual  Report on Form 10-K for the year
ended May 31, 2005,  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
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,

                                       31
<PAGE>
     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.

     We  recognized  deferred  revenues  of  $262,500  and  $247,500  related to
in-service  and  training  and  $1,157,085  and  $381,667   related  to  service
arrangements during the year ended May 31, 2005, and May 31, 2004, respectively.
In addition,  following the adoption of the  provisions of EITF 00-21  beginning
September 1, 2003 we began to defer revenue that had previously been recorded at
the time of sale.

     Previously,  in accordance with Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial  Statements,"  we accrued costs  associated  with these
arrangements  as  warranty  expense in the period the system was  delivered  and
accepted.  During fiscal year 2005 and 2004, we deferred  $187,500 and $340,000,
respectively,  related to  in-service  and training and $765,001 and  $1,040,000
related to service arrangements,  respectively. The amount related to in-service
and training is recognized as revenue at the time the in-service and training is
completed  and the amount  related  to service  arrangements  is  recognized  as
service revenue 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 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.  Deferred  revenues  recognized
related to extended  service  agreements  that have been  invoiced to  customers
prior to the performance of these  services,  were $1,900,925 and $1,485,372 for
the fiscal  years ended May 31,  2005,  and May 31,  2004,  respectively.  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.  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 sales 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,
2005.

Accounts Receivable/Financing Receivables
     The Company's accounts receivable - trade are due from customers engaged in
the provision of medical  services.  Credit is extended based on evaluation of a

                                       32
<PAGE>

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.  The Company
also looks at the credit  quality of its customer base as well as changes in its
credit policies. The Company continuously monitors collections and payments from
its customers.  While credit losses have historically  been within  expectations
and the  provisions  established,  the  Company  cannot  guarantee  that it will
continue to experience the same credit loss rates that it has in the past.

     In  addition,  the  Company  periodically  reviews  and  assesses  the  net
realizability of its 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 first quarter of fiscal 2003 and the second quarter
of fiscal 2004,  management  decided to write-off  financing  receivables  under
sales-type leases of approximately $2,558,000 and $680,000,  respectively,  as a
result of significant  uncertainties with respect to these customers' ability to
meet their financial obligations.

Inventories, net

     The Company values inventory at the lower of cost or estimated market, cost
being  determined on a first-in,  first-out basis. The Company often places 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.  The Company  records the cost of refurbished  components of EECP systems
and  critical  components  at cost plus the cost of  refurbishment.  The Company
regularly reviews inventory  quantities on hand,  particularly raw materials and
components,  and records 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.

Deferred Revenues

     We record revenue on extended  service  contracts  ratably over the term of
the related warranty  contracts.  Effective  September 1, 2003, we prospectively
adopted the  provisions of EITF 00-21.  Upon adoption of the  provisions of EITF
00-21  effective  September 1, 2003, we began to defer  revenue  related to EECP
domestic  system  sales for the fair value of  in-service  and  training  to the
period when the services are  rendered and for service  arrangement  obligations
ratably over the service period, which is generally one year.

Warranty Costs

     Equipment  sold is  generally  covered  by a  warranty  period of one year.
Effective  September  1, 2003,  we  adopted  the  provisions  of EITF 00-21 on a
prospective basis. Under EITF 00-21, 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 no
longer accrue  warranty  costs upon delivery but rather  recognize  warranty and
related  service  costs as incurred.  Prior to  September 1, 2003,  we accrued a
warranty  reserve for  estimated  costs to provide  warranty  services  when the
equipment sale was recognized.

     Equipment sold to international  customers through our distributor  network
is  generally  covered by a one year  warranty  period.  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 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.

                                       33
<PAGE>

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  change,  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  recorded  relates
primarily to the realization of net operating loss  carryforwards,  of which the
allocation of the current portion, if any, reflects the expected  utilization of
such net operating  losses in next twelve months.  Such  allocation is based our
internal  financial  forecast  and may be subject to revision  based upon actual
results.

Stock-based Employee Compensation

     We have five  stock-based  employee  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.

     Pro forma compensation  expense may not be indicative of future disclosures
because it does not take into effect pro forma  compensation  expense related to
grants before 1995.  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  Standards

     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.

     In December 2004, the Financial  Accounting  Standards  Board (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

                                       34
<PAGE>

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  December  2004,  the FASB  issued  Statement  of  Financial  Accounting
Standards  No.  123(R)  ("SFAS  No.   123(R)"),   "Accounting   for  Stock-Based
Compensation".  SFAS No. 123(R)  establishes  standards for the  accounting  for
transactions  in which an entity  exchanges its equity  instruments for goods or
services.  This Statement  focuses  primarily on accounting for  transactions in
which an entity obtains employee services in share-based  payment  transactions.
SFAS No.  123(R)  requires  that the fair value of such  equity  instruments  be
recognized  as expense in the  historical  financial  statements as services are
performed.  Prior to SFAS No. 123(R), only certain pro-forma disclosures of fair
value were  required.  SFAS No.  123(R) shall be effective for the Company as of
the beginning of the first interim  reporting  period that begins after June 15,
2005.  The adoption of this new accounting  pronouncement  is expected to have a
material impact on the financial  statements of the Company  commencing with the
quarter ending November 30, 2005.

     In  November  2004,  the FASB  issued  Statement  of  Financial  Accounting
Standards No. 151 ("SFAS No. 151"), Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 will improve financial  reporting
by clarifying that abnormal amounts of idle facility expense,  freight, handling
costs, and wasted materials  (spoilage)  should be recognized as  current-period
charges  and by  requiring  the  allocation  of fixed  production  overheads  to
inventory  based on the normal capacity of the production  facilities.  SFAS No.
151 is effective  for inventory  costs  incurred  during fiscal years  beginning
after June 15, 2005.  Earlier  application  is  permitted  for  inventory  costs
incurred  during fiscal years  beginning after November 24, 2004. The Company is
currently  evaluating  the impact of adoption  of SFAS No. 151 on its  financial
position and results of operations.

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

     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.

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 May 31, 2005, 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.

                                       35
<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 2005 Annual Meeting of Stockholders,  and is incorporated
herein by reference.

ITEM 11 - EXECUTIVE COMPENSATION

     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 2005 Annual Meeting of Stockholders,  and is incorporated
herein by reference.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     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 2005 Annual Meeting of Stockholders,  and is incorporated
herein by reference.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     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 2005 Annual Meeting of Stockholders,  and is incorporated
herein by reference.

ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES

     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 2005 Annual Meeting of Stockholders,  and is incorporated
herein by reference.

                                       36

<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 i 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)  Termination  and  Settlement  Agreement  dated  October 21, 2002,
               between the Registrant and D. Michael Deignan (14)
          (i)  Employment Agreement dated October 28, 2002, and amended June 30,
               2003, between the Registrant and Photios T. Paulson (14) (16)
          (j)  Amendment and Waiver to Credit  Agreement dated October 18, 2002,
               between the Vasomedical, Inc. and Fleet National Bank (14)
          (k)  Amendment  No. 2 and Waiver to Credit  Agreement  dated April 10,
               2003, between the Registrant and Fleet National Bank (15)
          (l)  Employment  Agreement dated September 8, 2003, between Registrant
               and Thomas W. Fry (17)
          (m)  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)
          (n)  Registration  Rights  Agreement,  dated  July 19,  2005,  between
               Vasomedical, Inc. and the Investors (18)

     (22) Subsidiaries of the Registrant

                                                                Percentage
        Name                    State of Incorporation       Owned by Company
        ----                    ----------------------       ----------------
        Viromedics, Inc.                Delaware                   61%
        180 Linden Avenue Corp.         New York                  100%

     (23) Consent of Grant Thornton LLP
     (31) Certification   Reports  pursuant  to  Securities  Exchange  Act  Rule
          13A-14(A)/15D-14(A)
     (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.
(6)  Incorporated by reference to Notice of Annual Meeting of Stockholders dated
     December 5, 1995.

                                       37
<PAGE>

(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 8-K dated June 30, 2003.
(17) Incorporated  by reference to Report on Form 10-Q for the quarterly  period
     ended February 29, 2004.
(18) Incorporated by reference to Report on Form 8-K dated July 19, 2005.

                                       38
<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 16 day of August, 2005.

                                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 16, 2004, by the following persons in the
capacities indicated:

______________________          Director
Alexander G. Bearn

/s/ David S. Blumenthal         Director
David S. Blumenthal

/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
Thomas W. Fry                   and Accounting Officer)

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

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

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

/s/ E. Donald Shapiro           Director
E. Donald Shapiro

/s/ Anthony Viscusi             Director
Anthony Viscusi

/s/ Forrest R. Whittaker        Director
Forrest R. Whittaker

/s/ Martin Zeiger               Director
Martin Zeiger

                                       39
<PAGE>

                       Vasomedical, Inc. and Subsidiaries

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                         Page
                                                                         -----

Report of Independent Registered Public Accounting Firm                   F-1

Financial Statements
    Consolidated Balance Sheets as of May 31, 2005 and 2004               F-2

    Consolidated Statements of Operations for the
    years ended May 31, 2005, 2004 and 2003                               F-3

    Consolidated Statement of Changes in Stockholders'
    Equity for the years ended May 31, 2005, 2004 and 2003                F-4

    Consolidated Statements of Cash Flows for the
    years ended May 31, 2005, 2004 and 2003                               F-5

    Notes to Consolidated Financial Statements                      F-6 - F-26

Financial Statement Schedule
    Schedule II - Valuation and Qualifying Accounts                       S-1

                                       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   sheets  of
Vasomedical,  Inc. and Subsidiaries (the "Company") as of May 31, 2005 and 2004,
and the related consolidated statements of operations,  stockholders' equity and
cash flows for each of the three 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  2004,  and the
consolidated  results of their operations and their  consolidated cash flows for
each of the three  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
GRANT THORNTON LLP


Melville, New York
July 29, 2005


                                      F-1
<PAGE>
                       Vasomedical, Inc. and Subsidiaries

                          CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                                             May 31,
                                                                                    2005                 2004
                                                                              -----------------    -----------------
                                 ASSETS
CURRENT ASSETS
<S>                                                                             <C>                  <C>
     Cash and cash equivalents                                                  $    989,524         $  6,365,049
     Certificates of deposit                                                       1,758,443            1,180,540
     Accounts receivable, net of an allowance for doubtful accounts of
       $394,692 and $699,203 at May 31, 2005 and 2004, respectively                1,892,002            5,521,853
     Inventories, net                                                              3,360,272            2,373,748
     Other current assets                                                            223,902              272,513
                                                                              -----------------    -----------------
         Total current assets                                                      8,224,143           15,713,703

PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,626,983
   and $2,378,576 at May 31, 2005 and 2004, respectively                           2,234,153            2,430,521
DEFERRED INCOME TAXES                                                             14,582,000           14,582,000
OTHER ASSETS                                                                         321,174              297,391
                                                                              -----------------    -----------------
                                                                                 $25,361,470          $33,023,615
                                                                              =================    =================


                  LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
     Accounts payable and accrued expenses                                      $  1,569,131         $  2,972,184
     Current maturities of long-term debt and notes payable                          148,212              136,478
     Sales tax payable                                                               216,753              353,360
     Deferred revenue                                                              1,667,080            1,734,925
     Accrued warranty and customer support expenses                                  110,583              161,917
     Accrued professional fees                                                       401,511              241,486
     Accrued commissions                                                             178,104              341,483
                                                                              -----------------    -----------------
         Total current liabilities                                                 4,291,374            5,941,833

LONG-TERM DEBT                                                                       947,597            1,092,837
ACCRUED WARRANTY COSTS                                                                 7,750               83,000
DEFERRED REVENUE                                                                     884,452            1,111,526
OTHER LIABILITIES                                                                     67,500              200,250

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;
       58,552,688 and 58,419,356 shares at May 31, 2005 and 2004,
       respectively, issued and outstanding                                           58,552               58,419
     Additional paid-in capital                                                   51,450,639           51,320,106
     Accumulated deficit                                                         (32,346,394)         (26,784,356)
                                                                              -----------------    -----------------
         Total stockholders' equity                                               19,162,797           24,594,169
                                                                              -----------------    -----------------
                                                                                 $25,361,470          $33,023,615
                                                                              =================    =================
The accompanying notes are an integral part of these financial statements.
</TABLE>

                                      F-2
<PAGE>

                       Vasomedical, Inc. and Subsidiaries

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                                  Year Ended May 31,
                                                                   -------------------------------------------------
                                                                       2005             2004              2003
                                                                   --------------    -------------     -------------
<S>                                                                 <C>               <C>               <C>
Revenues
   Equipment sales                                                  $11,516,883       $19,302,593       $22,850,391
   Equipment rentals and services                                     3,578,895         2,904,444         1,973,228
                                                                   --------------    -------------     -------------
                                                                     15,095,778        22,207,037        24,823,619

Cost of Sales and Services
   Cost of sales, equipment                                           4,223,523         6,309,119         8,050,389
   Cost of equipment rentals and services                             1,281,012         1,280,984         1,200,832
                                                                   --------------    -------------     -------------
                                                                      5,504,535         7,590,103         9,251,221
                                                                   --------------    -------------     -------------
   Gross profit                                                       9,591,243        14,616,934        15,572,398

Expenses
   Selling, general and administrative                               12,006,774        12,910,997        13,714,913
   Research and development                                           3,064,683         3,748,389         4,544,822
   Provision for doubtful accounts                                       11,084         1,296,759         3,728,484
   Interest and financing costs                                         105,232           132,062           186,574
   Interest and other income, net                                       (74,153)          (99,393)         (176,724)
                                                                   --------------    -------------     -------------
                                                                     15,113,620        17,988,814        21,998,069
                                                                   --------------    -------------     -------------
LOSS BEFORE INCOME TAXES                                             (5,522,377)       (3,371,880)       (6,425,671)
   Income tax (expense) benefit, net                                    (39,661)          (50,640)        1,634,688
                                                                   --------------    -------------     -------------
NET LOSS                                                            $(5,562,038)      $(3,422,520)      $(4,790,983)
                                                                   ==============    =============     =============

Net loss per common share
     - basic                                                            $(0.10)           $(0.06)           $(0.08)
                                                                   ==============    =============     =============
     - diluted                                                          $(0.10)           $(0.06)           $(0.08)
                                                                   ==============    =============     =============
Weighted average common shares outstanding
     - basic                                                         58,547,574        57,981,963        57,647,032
                                                                   ==============    =============     =============
     - diluted                                                       58,547,574        57,981,963        57,647,032
                                                                   ==============    =============     =============

The accompanying notes are an integral part of these financial statements.
</TABLE>

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

            CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                         Additional                               Total
                                              Common Stock                Paid-in-         Accumulated         Stockholders
                                          Shares         Amount           Capital           Deficit              Equity
                                        -------------------------     ---------------    ---------------    ---------------
<S>                                      <C>             <C>             <C>               <C>                 <C>
Balance at May 31, 2002                  57,309,120      $57,309         $50,116,148       $(18,570,853)       $31,602,604

   Exercise of options and warrants         512,903          513             234,487                               235,000
   Stock options granted for services                                         50,681                                50,681
   Tax benefit of stock options and
     warrants                                                                222,000                               222,000
   Net loss                                                                                  (4,790,983)        (4,790,983)
                                       ------------  ------------       ------------       -------------       ------------

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
                                       ============  ============       ============       =============       ============

        The accompanying notes are an integral part of this financial statement.
</TABLE>

                                                                        F-4
<PAGE>

                       Vasomedical, Inc. and Subsidiaries

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                                  Year ended May 31,
                                                                   -------------------------------------------------
                                                                       2005              2004              2003
                                                                   --------------    -------------     -------------
<S>                                                                <C>               <C>               <C>
Cash flows from operating activities
     Net loss                                                      $(5,562,038)      $(3,422,520)      $(4,790,983)
                                                                   --------------    -------------     -------------
     Adjustments to reconcile net loss to net cash
       provided by (used in) operating activities
         Depreciation and amortization                                 578,530           749,111         1,132,996
         Provision for doubtful accounts                                11,084           616,759         2,209,101
         Reserve for excess and obsolete inventory                     166,672           119,000           100,000
         Deferred income taxes                                              --                --        (1,669,000)
         Stock options granted for services                                 --                --            50,681
         Changes in operating assets and liabilities
              Accounts receivable                                    3,618,767         1,923,284         5,643,288
              Financing receivables, net                                    --           258,608           118,126
              Inventories                                           (1,295,294)        1,187,761         1,079,976
              Other current assets                                      48,611            (4,282)          359,012
              Other assets                                             (63,649)          (69,610)          (79,082)
              Accounts payable, accrued expenses and other
                current liabilities                                 (1,662,193)          517,056        (1,286,324)
              Other liabilities                                       (435,074)          (38,907)          311,813
                                                                   --------------    -------------     -------------
                                                                       967,454         5,258,780         7,970,587
                                                                   --------------    -------------     -------------
     Net cash provided by (used in) operating activities            (4,594,584)        1,836,260         3,179,604
                                                                   --------------    -------------     -------------

     Cash flows (used in) investing activities
         Purchase of certificates of deposit and treasury           (3,747,903)       (1,180,540)               --
            bills
         Redemptions of certificates of deposit and                  3,170,000                --                --
           treasury bills
         Purchase of property and equipment                           (200,198)         (153,954)         (326,489)
                                                                   --------------    -------------     -------------
     Net cash (used in) investing activities                          (778,101)       (1,334,494)         (326,489)
                                                                   --------------    -------------     -------------

     Cash flows provided by (used in) financing activities
         Proceeds from notes payable                                        --            67,149           238,071
         Payments on notes payable                                    (133,506)         (124,100)       (1,070,966)
         Proceeds from exercise of options and warrants                130,666           697,387           235,000
                                                                   --------------    -------------     -------------
     Net cash provided by (used in) financing activities                (2,840)          640,436          (597,895)
                                                                   --------------    -------------     -------------


NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS                                                         (5,375,525)        1,142,202         2,255,220
                                                                   --------------    -------------     -------------
     Cash and cash equivalents - beginning of year                   6,365,049         5,222,847         2,967,627
                                                                   --------------    -------------     -------------
     Cash and cash equivalents - end of year                       $   989,524        $6,365,049        $5,222,847
                                                                   ==============    =============     =============

Non-cash investing and financing activities were as follows:
     Inventories    transferred   to   (from)   property   and
       equipment, attributable to operating leases - net             $(142,098)        $(240,942)         $761,986

Supplement disclosures:
   Interest paid                                                      $105,232          $105,194          $186,574
   Income taxes paid                                                   $19,888           $24,213           $87,963

    The accompanying notes are an integral part of these financial statements.
</TABLE>

                                      F-5
<PAGE>

                       Vasomedical Inc. and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                           May 31, 2005, 2004 and 2003


NOTE A - BUSINESS ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     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.

     We believe  that our cash flow from  operations  together  with our current
cash reserves and the cash received for the sale of convertible  preferred stock
and  warrants  on July 19,  2005 (see Note O),  will be  sufficient  to fund our
business plan and projected capital  requirements through at least May 31, 2006.
However, we have incurred  significant losses during the last three fiscal years
and our  long-term  ability to maintain  current  operations  is dependent  upon
achieving profitable operations,  which is largely dependent upon the successful
commercialization  of EECP therapy into the congestive heart failure indication,
and depends in part upon the  acceptance  of the  results of the PEECH  clinical
trial by the medical  community and expanded  reimbursement  coverage to include
CHF as being  sufficient  to promote  the  adoption  of EECP  therapy in CHF; or
through  additional  debt or  equity  financing.  In the event  that  additional
capital is required, we may seek to raise such capital through public or private
equity or debt financings.  Future capital funding, if available,  may result in
dilution to current shareholders.

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

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
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 in the United States
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

                                      F-6
<PAGE>

                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


     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. for 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.

     We  recognized  deferred  revenues  of  $262,500  and  $247,500  related to
in-service  and  training  and  $1,157,085  and  $381,667   related  to  service
arrangements  during the years  ended May 31,  2005 and 2004,  respectively.  In
addition,  following  the  adoption of the  provisions  of EITF 00-21  beginning
September 1, 2003, we began to defer revenue that had  previously  been recorded
at the time of sale.

     Previously,  in accordance with Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial  Statements,"  we accrued costs  associated  with these
arrangements  as  warranty  expense in the period the system was  delivered  and
accepted. During the years ended May 31, 2005 and 2004, we deferred $187,500 and
$340,000 related to in- service and training and $765,001 and $1,040,000 related
to service  arrangements,  respectively.  The amount  related to in- service and
training is  recognized  as revenue at the time the  in-service  and training is
completed  and the amount  related  to service  arrangements  is  recognized  as
service revenue 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 sales as incurred.

     The following tables  illustrate the effect on revenues,  cost of sales and
services,  net loss,  and net loss per common share had the Company  applied the
provisions of "Revenue Arrangements with Multiple  Deliverables" (EITF 00-21) as
if the provisions had been adopted prior to fiscal 2003:

<TABLE>
<CAPTION>
                                                                  Year Ended May 31, 2003
                                                -------------------------------------------------------------
                                                   As reported         EITF adjustment         Pro forma
                                                -------------------    -----------------    -----------------
<S>                                                 <C>                    <C>                <C>
Revenues                                            $24,823,619            $(26,458)          $24,797,161
 Cost of sales and services                           9,251,221             (16,333)            9,234,888
                                                -------------------    -----------------    -----------------
Gross profit                                         15,572,398             (10,125)           15,562,273
Operating expenses                                   21,998,069                  --            21,998,069
                                                -------------------    -----------------    -----------------
Loss before income taxes                             (6,425,671)            (10,125)           (6,435,796)
Income tax (expense) benefit, net                     1,634,688                  --             1,634,688
                                                -------------------    -----------------    -----------------
Net loss                                            $(4,790,983)           $(10,125)          $(4,801,108)
                                                ===================    =================    =================

Net loss per common share, basic and diluted             $(0.08)                                   $(0.08)
Weighted average common shares                       57,647,032                                57,647,032
</TABLE>

                                      F-7
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

<TABLE>
<CAPTION>

                                                                  Year Ended May 31, 2004
                                                -------------------------------------------------------------
                                                   As reported         EITF adjustment         Pro forma
                                                -------------------    -----------------    -----------------
<S>                                                 <C>                    <C>                <C>
Revenues                                            $22,207,037            $730,208           $22,937,245
 Cost of sales and services                           7,590,103             369,000             7,959,103
                                                -------------------    -----------------    -----------------
Gross profit                                         14,616,934             361,208            14,978,142
Operating expenses                                   17,988,814                  --            17,988,814
                                                -------------------    -----------------    -----------------

Loss before income taxes                             (3,371,880)            361,208            (3,010,672)
Income tax (expense) benefit, net                       (50,640)                 --               (50,640)
                                                -------------------    -----------------    -----------------
Net loss                                            $(3,422,520)           $361,208           $(3,061,312)
                                                ===================    =================    =================


Net loss per common share, basic and diluted             $(0.06)                                   $(0.05)
Weighted average common shares                       57,981,963                                57,981,963


                                                                  Year Ended May 31, 2005
                                                -------------------------------------------------------------
                                                   As reported         EITF adjustment         Pro forma
                                                -------------------    -----------------    -----------------
Revenues                                            $15,095,778             $50,000           $15,145,778
 Cost of sales and services                           5,504,535             (26,667)            5,477,868
                                                -------------------    -----------------    -----------------
Gross profit                                          9,591,243              76,667             9,667,910
Operating expenses                                   15,113,620                  --            15,113,620
                                                -------------------    -----------------    -----------------
Loss before income taxes                             (5,522,377)             76,667            (5,445,710)
Income tax (expense) benefit, net                       (39,661)                 --               (39,661)
                                                -------------------    -----------------    -----------------
Net loss                                            $(5,562,038)            $76,667           $(5,485,371)
                                                ===================    =================    =================

Net loss per common share, basic and diluted             $(0.10)                                   $(0.10)
Weighted average common shares                       58,547,574                                58,547,574

</TABLE>

     Revenues  from  the  sale  of  EECP  systems   through  our   international
distributor  network are generally  covered by a one-year  warranty period.  For
these  customers  we accrue a warranty  reserve for  estimated  costs to provide
warranty services when the equipment sale is recognized.

     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 warranty  agreements on the
EECP  system are  deferred  and  recognized  ratably  over the  service  period,
generally  ranging  from one year to four years.  Deferred  revenues  recognized
related to extended  warranty  agreements  that have been  invoiced to customers
prior to the performance of these  services,  were $1,900,925 and $1,485,372 for
the years ended May 31, 2005 and 2004,  respectively.  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.

     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

                                      F-8
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

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 sales 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,
2005.

Accounts Receivable/Financing Receivables

     The Company's 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.  The Company
also looks at the credit  quality of its customer base as well as changes in its
credit policies. The Company continuously monitors collections and payments from
its customers.  While credit losses have historically  been within  expectations
and the  provisions  established,  the  Company  cannot  guarantee  that it will
continue to experience the same credit loss rates that it has in the past.

     The  changes  in the  Company's  allowance  for  doubtful  accounts  are as
follows:
<TABLE>
<CAPTION>
                                                                      Year Ended May 31,
                                                  -----------------------------------------------------------
                                                         2005                 2004                2003
                                                  -------------------    ---------------     ----------------
<S>                                                   <C>                    <C>               <C>
Beginning balance                                     $699,203               $768,629          $1,099,687
    Provision for losses on accounts
    receivable                                          11,084                616,759           1,227,324
    Direct write-offs, net of recoveries              (315,595)              (686,185)         (1,558,382)
                                                  -------------------    ---------------     ----------------
Ending balance                                        $394,692               $699,203            $768,629
                                                  ===================    ===============     ================
</TABLE>
     In addition,  we periodically  review and assess the net  realizability  of
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 first  quarter of fiscal 2003 and the second  quarter of fiscal 2004,  we
decided  to  write-off   financing   receivables   under  sales-type  leases  of
approximately $2,558,000 and $680,000,  respectively, as a result of significant
uncertainties  with respect to these customers'  ability to meet their 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,
                                                  -----------------------------------------------------
                                                       2005               2004               2003
                                                  ---------------    ---------------    ---------------
<S>                                                       <C>           <C>                <C>
Beginning balance                                         $--           $244,994           $718,879
    Provision for losses on financing
      receivables                                          --            680,000                 --
    Direct write-offs                                      --           (924,994)          (473,885)
                                                  ---------------    ---------------    ---------------
Ending balance                                            $--                $--           $244,994
                                                  ===============    ===============    ===============
</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,  believes  that its  receivable  credit risk exposure is
limited.  Receivables  are  generally due 30 to 90 days from  shipment.  For the
years ended May 31, 2005,  2004 and 2003, no customer  accounted for 10% or more
of  revenues.  At May 31,  2005,  one  customer  accounted  for 13% of  accounts
receivable.  At May 31, 2004 and May 31, 2003, no customer accounted for greater
than 10% of accounts receivable.

                                      F-9
<PAGE>

                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003



         Our revenues were derived from the following geographic areas:
<TABLE>
<CAPTION>
                                                                    Year Ended May 31,
                                                   ------------------------------------------------------
                                                        2005                2004               2003
                                                   ---------------     ---------------    ---------------
<S>                                                 <C>                   <C>                <C>
Domestic (United States)                            $13,673,293           $21,339,267        $23,701,619
Non-domestic                                          1,422,485               867,770          1,122,000
                                                   ---------------     ---------------    ---------------
                                                    $15,095,778           $22,207,037        $24,823,619
                                                   ===============     ===============    ===============
</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 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)

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.  The
cost of  refurbished  components  of EECP  systems and critical  components  are
recorded at cost plus the cost of  refurbishment.  We regularly review inventory
quantities on hand,  particularly  raw materials and  components,  and records 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. (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 warranty  contracts.  Effective  September 1, 2003, we prospectively
adopted the  provisions of EITF 00-21.  Upon adoption of the  provisions of EITF
00-21  effective  September 1, 2003, we began to defer  revenue  related to EECP
domestic  system  sales for the fair value of in-  service  and  training to the
period when the services are  rendered and for service  arrangement  obligations
ratably over the service period, which is generally one year. (See Note G)

Warranty Costs

     Equipment  sold is  generally  covered  by a  warranty  period of one year.
Effective  September  1, 2003,  we  adopted  the  provisions  of EITF 00-21 on a
prospective  basis for our  shipments to customers in the United  States.  Under

                                      F-10
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

EITF 00-21,  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 no longer accrue  warranty  costs
upon  delivery for these  customers  but rather  recognize  warranty and related
service  costs as incurred.  Prior to  September 1, 2003,  we accrued a warranty
reserve for estimated costs to provide warranty services when the equipment sale
was  recognized.

     Equipment sold to international  customers through our distributor  network
is  generally  covered by a one year  warranty  period.  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  change,  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  recorded  relates
primarily to the realization of net operating loss  carryforwards,  of which the
allocation of the current portion, if any, reflects the expected  utilization of
such net operating  losses in next twelve months.  Such  allocation is based our
internal  financial  forecast  and may be subject to revision  based upon actual
results. (See Note L)

Shipping and Handling Costs

     The Company  includes  all shipping  and  handling  expenses  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
financing  receivables,  the  realizability  of  deferred  tax  assets,  and the
adequacy of inventory and warranty  reserves.  Actual  results could differ from
those estimates.

                                      F-11
<PAGE>

                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

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
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  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 the Company 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,
                                                  -----------------------------------------------------
                                                       2005               2004               2003
                                                  ---------------    ---------------    ---------------
<S>                                                <C>                <C>                <C>
Net loss, as reported                              $(5,562,038)       $(3,422,520)       $(4,790,983)
Deduct: Total stock-based employee compensation
   expense determined under fair value-based
   method for all awards                            (1,097,783)        (1,080,817)          (917,281)
                                                  ---------------    ---------------    ---------------
Pro forma net loss                                 $(6,659,821)       $(4,503,337)       $(5,708,264)
                                                  ===============    ===============    ===============

Loss per share:
    Basic and diluted - as reported                  $(0.10)             $(0.06)            $(0.08)
    Basic and diluted - pro forma                    $(0.11)             $(0.08)            $(0.10)
</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.  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,
                                                  -----------------------------------------------------
                                                       2005               2004               2003
                                                  ---------------    ---------------     --------------
<S>                                                       <C>                <C>                 <C>
Expected life (years)                                     5                  5                   5
Expected volatility                                      81%                89%                 89%
Risk-free interest rate                                 4.4%               3.4%                3.0%
Expected dividend yield                                 0.0%               0.0%                0.0%
</TABLE>

                                      F-12
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

     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.

Impact of New Accounting Pronouncements

     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.

     In December 2004, the Financial  Accounting  Standards  Board (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  December  2004,  the FASB  issued  Statement  of  Financial  Accounting
Standards  No.  123(R)  ("SFAS  No.   123(R)"),   "Accounting   for  Stock-Based
Compensation".  SFAS No. 123(R)  establishes  standards for the  accounting  for
transactions  in which an entity  exchanges its equity  instruments for goods or
services.  This Statement  focuses  primarily on accounting for  transactions in
which an entity obtains employee services in share-based  payment  transactions.
SFAS No.  123(R)  requires  that the fair value of such  equity  instruments  be
recognized  as expense in the  historical  financial  statements as services are
performed.  Prior to SFAS No. 123(R), only certain pro-forma disclosures of fair
value were  required.  SFAS No.  123(R) shall be effective for the Company as of
the beginning of the first interim  reporting  period that begins after June 15,
2005.  The adoption of this new accounting  pronouncement  is expected to have a
material impact on the financial  statements of the Company  commencing with the
quarter ending November 30, 2005.

     In  November  2004,  the FASB  issued  Statement  of  Financial  Accounting
Standards No. 151 ("SFAS No. 151"), Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 will improve financial  reporting
by clarifying that abnormal amounts of idle facility expense,  freight, handling
costs, and wasted materials  (spoilage)  should be recognized as  current-period
charges  and by  requiring  the  allocation  of fixed  production  overheads  to
inventory  based on the normal capacity of the production  facilities.  SFAS No.
151 is effective  for inventory  costs  incurred  during fiscal years  beginning
after June 15, 2005.  Earlier  application  is  permitted  for  inventory  costs
incurred  during fiscal years  beginning after November 24, 2004. The Company is
currently  evaluating  the impact of adoption  of SFAS No. 151 on its  financial
position and results of operations.

                                      F-13
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


NOTE B - LOSS PER COMMON SHARE

     The following  table sets forth the  computation  of basic and diluted loss
per share:
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2005               2004               2003
                                                  ---------------    ---------------     --------------
<S>                                                 <C>                <C>                 <C>
Numerator:
   Net loss                                         $(5,562,038)       $(3,422,520)        $(4,790,983)
Denominator:
   Basic - weighted average shares                   58,547,574         57,981,963          57,647,032
         Stock options                                       --                 --                  --
         Warrants                                            --                 --                  --
                                                  ---------------    ---------------     --------------
   Diluted - weighted average shares                 58,547,574         57,981,963          57,647,032
                                                  ===============    ===============     ==============

Loss per share - basic                                   $(0.10)            $(0.06)             $(0.08)
                                                  ===============    ===============     ==============
               - diluted                                 $(0.10)            $(0.06)             $(0.08)
                                                  ===============    ===============     ==============
</TABLE>

     Options and warrants to purchase 6,745,544,  5,161,751 and 6,190,753 shares
of common stock were excluded from the computation of diluted earnings per share
for the years  ended May 31,  2005,  2004 and 2003,  respectively,  because  the
effect of their inclusion would be antidilutive.

NOTE C - CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>

         Cash and cash equivalents consist of the following:
                                                                             May 31,
                                                                ----------------------------------
                                                                     2005               2004
                                                                ---------------    ---------------
<S>                                                                  <C>              <C>
Cash accounts                                                        $987,314         $2,522,570
Money market funds                                                      2,210          3,842,479
                                                                ---------------    ---------------
                                                                     $989,524         $6,365,049
                                                                ===============    ===============
NOTE D - INVENTORIES, NET

         Inventories, net consist of the following:
                                                                             May 31,
                                                                ----------------------------------
                                                                     2005               2004
                                                                ---------------    ---------------
Raw materials                                                     $   960,101        $   928,269
Work in process                                                     1,194,688            455,731
Finished goods                                                      1,205,483            989,748
                                                                ---------------    ---------------
                                                                  $ 3,360,272        $ 2,373,748
                                                                ===============    ===============
</TABLE>

     At May 31, 2005 and 2004, the Company has recorded  reserves for excess and
obsolete inventory of $566,149 and $399,477, respectively.

NOTE E - FINANCING RECEIVABLES FROM MAJOR CUSTOMERS

     In fiscal year 2002, the Company sold its external counterpulsation systems
("EECP"  units) to two  major  customers  engaged  in  establishing  independent
networks  of EECP  centers  under  sales-type  leases  aggregating  revenues  of
$4,187,009  in fiscal  year  2002.  No  additional  equipment  was sold to these
customers during fiscal 2003 or 2004.

                                      F-14

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

     In  late  August  2002,  the  largest  customer  became  delinquent  in its
scheduled  monthly payments under its financing  obligations to the Company.  In
September   2002,   the  Company  was  notified  by  this   customer  of  recent
circumstances  that  precluded  their  ability  to remain  current  under  their
financing  obligations  to  the  Company.  Accordingly,  management  decided  to
write-off,  in full,  all funds due from this  customer  as of August 31,  2002,
which aggregated approximately $3,000,000, including the present carrying amount
of the underlying  equipment due to the uncertainty of the Company's  ability to
repossess  the  equipment.  During the second  quarter of fiscal year 2003,  the
customer ceased operations and the Company was able to successfully  recover all
of the units that it had sold under sales-type  leases to the customer back into
its finished goods inventory and recorded a bad debt recovery of $479,000, which
represented  the  carrying  amount at that  time of the  equipment.  The  second
customer became  delinquent in its scheduled  monthly payments during the fourth
quarter of fiscal 2003.  During the first and second quarters of fiscal 2004 the
customer  attempted to remedy the situation and made payments  totaling $70,000.
In December  2003,  the  customer  ceased  operations.  Accordingly,  management
decided to write- off all funds due from this  customer as of November 30, 2003,
less  the  anticipated  recovery  of  equipment  and the  reduction  of  related
liabilities for sales tax. The write-off of  approximately  $680,000 is included
as a component  of the  provision  for  doubtful  accounts  in the  accompanying
Statement of Operations for the year ended May 31, 2004. In the third quarter of
fiscal 2004, the Company  recovered all of the EECP systems that had been leased
to this customer. The Company is no longer offering sales-type leases.

NOTE F - PROPERTY AND EQUIPMENT

     Property and equipment is summarized as follows:

<TABLE>
<CAPTION>
                                                                             May 31,
                                                                -----------------------------------
                                                                     2005               2004
                                                                ---------------    ----------------
<S>                                                              <C>                <C>
Land                                                              $  200,000         $  200,000
Building and improvements                                          1,383,976          1,382,270
Office, laboratory and other equipment                             1,445,168          1,246,089
EECP systems  under  operating  leases or under loan
   for clinical trials                                             1,552,121          1,700,867
Furniture and fixtures                                               162,068            162,068
Leasehold improvements                                               117,803            117,803
                                                                ---------------    ----------------
                                                                   4,861,136          4,809,097
                                                                ---------------    ----------------
Less: accumulated depreciation and amortization                   (2,626,983)        (2,378,576)
                                                                ---------------    ----------------
                                                                  $2,234,153         $2,430,521
                                                                ===============    ================
</TABLE>

                                      F-15

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

NOTE G - DEFERRED REVENUE

         The changes in the Company's deferred revenues are as follows:
<TABLE>
<CAPTION>
                                                                   Year Ended May 31,
                                                  -----------------------------------------------------
                                                       2005               2004               2003
                                                  ---------------    ---------------    ---------------
<S>                                                 <C>                <C>                  <C>
Deferred revenue at beginning of year               $2,846,451         $1,709,551           $991,204
ADDITIONS
   Deferred extended service contracts               2,073,090          1,871,439          1,478,933
   Deferred in-service and training                    187,500            340,000                 --
   Deferred service arrangement obligations            765,001          1,040,000                 --
RECOGNIZED AS REVENUE
   Deferred extended service contracts              (1,900,925)        (1,485,372)          (760,586)
   Deferred in-service and training                   (262,500)          (247,500)                --
   Deferred service arrangement obligations         (1,157,085)          (381,667)                --
                                                  ---------------    ---------------    ---------------
Deferred revenue at end of year                      2,551,532          2,846,451          1,709,551
   Less: current portion                            (1,667,080)        (1,734,925)          (789,118)
                                                  ---------------    ---------------    ---------------
Long-term deferred revenue at end of year             $884,452         $1,111,526           $920,433
                                                  ===============    ===============    ===============
</TABLE>
NOTE H - WARRANTY LIABILITY

The changes in the Company's product warranty liability are as follows:
<TABLE>
<CAPTION>
                                                                    Year Ended May 31,
                                                  -------------------------------------------------------
                                                       2005                2004               2003
                                                  ---------------     ---------------    ----------------
<S>                                                    <C>                 <C>                <C>
Beginning balance                                      $244,917            $788,000           $991,000
  Expense for new warranties issued                      27,000             164,000            724,000
  Warranty claims                                      (153,584)           (707,083)          (927,000)
                                                  ---------------     ---------------    ----------------
Ending balance                                         $118,333            $244,917           $788,000
                                                  ===============     ===============    ================
</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,
                                                               ------------------------------------
                                                                    2005                2004
                                                               ----------------    ----------------
<S>                                                                 <C>               <C>
Facility loans (a)                                                  $969,566          $1,022,933
Term loans (b)                                                       126,243             206,382
                                                               ----------------    ----------------
                                                                   1,095,809           1,229,315
Less:  current portion                                              (148,212)           (136,478)
                                                               ----------------    ----------------
                                                                    $947,597          $1,092,837
                                                               ================    ================
</TABLE>
     (a) The Company  purchased  its  headquarters  and  warehouse  facility and
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.

                                      F-16

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

Maturities  of long-term  debt are as follows at May 31, 2005:
<TABLE>
<CAPTION>
                Fiscal Year                Amount
                -------------------     --------------
                <S>                          <C>
                2006                          148,212
                2007                           96,583
                2008                           65,769
                2009                           70,524
                2010                           75,629
                Thereafter                    639,093
                                        --------------
                                           $1,095,809
                                        ==============
</TABLE>
NOTE J - STOCKHOLDERS' EQUITY AND WARRANTS

     In fiscal 2003,  warrants to purchase  500,000  shares of common stock were
exercised,  aggregating  $225,000 in proceeds to the Company.  No warrants  were
exercised or cancelled in fiscal 2004 and 2005.

     All outstanding  warrants expire in October 2006.  Warrant activity for the
years ended May 31, 2003, 2004 and 2005 is summarized as follows:
<TABLE>
<CAPTION>
                                       Employees         Consultants               Total             Price Range
                                    ----------------- ------------------- ------------------------ ----------------
<S>                                       <C>               <C>                   <C>               <C>     <C>
Balance at May 31, 2002                   500,000           327,500               827,500           $0.45 - $2.08
  Exercised                              (500,000)               --              (500,000)              $0.45
  Cancelled                                    --          (127,500)             (127,500)              $2.08
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2003                        --           200,000               200,000               $0.91
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004                        --           200,000               200,000               $0.91
                                    ----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005                        --           200,000               200,000               $0.91
                                    ================= =================== ======================== ================
Number of shares exercisable                   --           200,000               200,000               $0.91
                                    ================= =================== ======================== ================
</TABLE>

NOTE K - 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.

Outside Director Stock Option Plan

     In May 1995, the Company's  stockholders approved an Outside Director Stock
Option 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 Outside  Director Stock Option 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  Outside  Director  Stock  Option  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

                                      F-17
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

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 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 to  purchase  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 vest over four years and 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.

     At May 31, 2005,  there were 4,500 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
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 December  2001,  the Board of Directors  granted stock options under the
1999 Plan to a  consultant  to  purchase  25,000  shares  of common  stock at an
exercise  price of $2.95 per share (which  represented  the fair market value of
the underlying  common stock at the time of the respective  grant).  These stock
options were  fair-valued  at $50,250,  which the Company  charged to operations
over the one-year period in which services were rendered. During fiscal 2003 and
2002, the Company charged $25,000 and $50,000,  respectively,  to operations for
these grants.

     In fiscal 2003, the Board of Directors granted stock non-qualified  options
under the 1999 Plan to  directors  and  employees  to purchase an  aggregate  of
1,175,000 shares of common stock, at exercise prices ranging from $0.71 to $1.67
per share  (which  represented  the fair market value of the  underlying  common
stock at the time of the respective grants).

     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  prices ranging from $0.91 to $1.31
per share  (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  purchase  under the 1999 Plan to an officer  to  purchase  an
aggregate of 2,194,832  shares of common stock, at an exercise price of $0.95 to

                                      F-18

<PAGE>

                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


$1.70 per share,  which  represented  the fair  market  value of the  underlying
common  stock  at  the  time  of  the  respective  grants.  These  options  vest
immediately, or over three-year and four-year periods, and expire five years and
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.

     At May 31, 2005,  there were 335,003  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
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 fiscal 2005,  the  Company's  Board of Directors  granted  non-qualified
stock  options to  purchase  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.  These options vest  immediately,  or over a
four-year period, and expire ten years from the date of grant.

     At May 31, 2005,  there were 2,275,000  shares  available for future grants
under the 2004 Plan.

                                      F-19

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


     Activity  under all the plans for the years  ended May 31,  2003,  2004 and
2005, 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>            <C>
Balance at May 31, 2002                 2,259,401           5,192,923         $0.78   -   $5.15          $2.51
  Options granted                      (1,175,000)          1,175,000         $0.71   -   $1.67          $0.95
  Options exercised                            --             (12,903)        $0.78                      $0.78
  Options canceled                        354,267            (364,267)        $0.88   -   $5.15          $3.77
                                    ----------------- ------------------- ------------------------ ----------------
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         $0.95   -   $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
                                    ================= =================== ======================== ================
</TABLE>

     (1) May be issued under the Stock Issuance Program.

     The following table summarizes  information about stock options outstanding
and exercisable at May 31, 2005
<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, 2005       Life (yrs.)                         May 31, 2005        Price
                              ------------------ ---------------- ---------------    ----------------- --------------
<S>       <C>                       <C>                 <C>             <C>                <C>               <C>
$0.71  -  $0.98                     1,553,000           6.9             $0.91              951,334           $0.88
$1.00  -  $1.48                     2,350,000           8.3             $1.11              546,664           $1.08
$1.53  -  $2.21                       947,544           3.2             $1.85              940,877           $1.85
$2.66  -  $3.44                       801,000           3.4             $3.24              801,000           $3.24
$3.50  -  $5.15                       894,000           5.6             $4.03              894,000           $4.03
                              ------------------ ---------------- ---------------    ----------------- --------------
                                    6,545,544           6.2             $1.83            4,133,875           $2.26
                              ================== ================ ===============    ================= ==============
</TABLE>

     The  weighted-average  fair value of options  granted  during  fiscal years
2005, 2004 and 2003 was $1.08, $1.06, and $0.95, respectively.  At May 31, 2005,
there were approximately  42,087,265 remaining authorized shares of common stock
after reserves for all stock option plans and stock warrants.

NOTE L - INCOME TAXES

     During the fiscal years ended May 31, 2005 and 2004, the Company recorded a
provision for state income taxes of $39,661 and $50,640, respectively. In fiscal
2003, the Company  recorded a benefit for income taxes of $1,634,688,  inclusive
of $256,312 in current tax expense and a deferred benefit of $1,891,000.

     As of May 31,  2005,  the  Company  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  amount of the  deferred  tax  assets
considered  realizable  could be reduced in the  future if  estimates  of future
taxable income during the carryforward period are reduced.  Ultimate realization
of the deferred tax assets is dependent upon the Company  generating  sufficient

                                      F-20

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

taxable income prior to the expiration of the tax loss carryforwards. Management
believes that the Company is positioned for long-term  growth despite the losses
during  fiscal years 2005 and 2004,  and that based upon the weight of available
evidence,  that it is "more  likely than not" that the net  deferred  tax assets
will be realized.  The "more  likely than not"  standard is  subjective,  and is
based upon management's estimate of a greater than 50% probability that its long
range business plan can be realized.

     Ultimate  realization  of any or all of  the  deferred  tax  assets  is not
assured, due to significant  uncertainties and material  assumptions  associated
with  estimates of future  taxable income during the  carryforward  period.  Our
estimates are largely  dependent upon achieving  considerable  growth in revenue
and profits resulting from the successful commercialization of EECP therapy into
the  congestive  heart  failure  indication,  which we  believe  to enable us to
reverse the current trend of increasing  losses and generate  pre-tax  income in
excess of $39 million over the next seven years in order to fully utilize all of
the deferred tax assets.  Such future  estimates  of future  taxable  income are
based on our beliefs,  as well as assumptions made by and information  currently
available to us.  Certain  critical  assumptions  associated  with our estimates
include:

     --   that the  results  from the  PEECH  clinical  trial,  as well as other
          clinical  evidence are  sufficiently  positive for the PEECH  clinical
          trial to be  published  in a peer  review  journal and enable the EECP
          therapy  to obtain  approval  for a  national  Medicare  reimbursement
          coverage policy plus other  third-party payer  reimbursement  policies
          specific to the congestive heart failure indication;
     --   that the reimbursement  coverage will be both broad enough in terms of
          coverage  language  and at an amount  adequate  to  enable  successful
          commercialization  of EECP therapy into the  congestive  heart failure
          indication  and enable us to achieve  material  growth in revenue  and
          profits;
     --   that the EECP therapy will be accepted by the medical  community as an
          adjunctive  therapy  for the  treatment  of  patients  suffering  from
          congestive heart failure; and
     --   that  we  will  be able to  secure  additional  financing  to  provide
          sufficient  funds to  market  EECP  therapy  in the  congestive  heart
          failure indication.

     Additional   uncertainties  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;
     --   other medical insurance reimbursement policies;
     --   there  can be no  assurance  that we will be able to raise  additional
          capital necessary to implement our business plan;
     --   unexpected manufacturing problems;
     --   unforeseen  difficulties and delays in the conduct of clinical trials,
          peer review publications 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;
     --   our recent financial history of declining revenues and losses; and
     --   the risk factors reported from time to time in our SEC reports.

     Factors  considered  by us in making our  assumptions  and  included in our
long-term business plan are the following:

     --   we currently  have FDA  clearance to market EECP therapy in congestive
          heart failure;
     --   independent  market  research  indicates  that the patient  population
          potentially  eligible for EECP  therapy in  congestive  heart  failure
          market is larger than the current refractory angina patient population
          and when the two patient  populations  are  combined  the total market
          opportunity for EECP therapy will be more than double;
     --   many  physician  practices  have  told  us  that  they  do not  have a
          sufficient number of patients to economically  justify adoption of the
          procedure  with the  current  reimbursement  coverage  for  refractory
          angina.  The increased  market size resulting from the addition of CHF
          patients could improve the economic model for the physician practice;
     --   we have positive  clinical evidence from the PEECH clinical trial that
          was  recently  concluded  as  disclosed  in the  above  "Research  and
          Development"  section, plus other smaller clinical trials and the IEPR
          patient registry that demonstrates the clinical  effectiveness of EECP
          therapy  in the  treatment  of  congestive  heart  failure  to medical
          providers, payers and regulators;

                                      F-21

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

     --   we completed the PEECH  clinical trial this fiscal year as planned and
          disclosed the summary results of the trial in March 2005;
     --   we intend to have the results of the PEECH trial  published  in a peer
          review  journal,  which is an important  step  necessary to support an
          application to CMS to expand reimbursement coverage of EECP therapy to
          include CHF patients;
     --   we sustained a period of  profitability in fiscal years 2000, 2001 and
          2002 with profits  before income taxes of  $1,290,916,  $5,237,242 and
          $4,240,106, respectively; and
     --   we continue to believe that we will be able to raise  sufficient funds
          to enable us to execute our business plan.

     While we believe that we will be able to execute our business plan over the
longer term and we will be able to utilize our tax loss carryforwards, the exact
timing of our return to  profitability  is  uncertain,  subject  to  significant
management  judgments  and  estimates  and  dependent  on a variety of  external
factors  including:  market  conditions at that time,  the reception of the EECP
therapy  by the  medical  professionals  and payers and the timing of a Medicare
reimbursement  decision.  It is possible that significant tax loss carryforwards
from fiscal years 2005, 2006 and 2007 may expire before we are able to use them.
As a result  of these  uncertainties,  beginning  in  fiscal  2004,  we began to
provide a valuation reserve for all additional tax loss  carryforwards that were
generated  by current  operating  losses.  We review  this policy on a quarterly
basis and believe  that the above  valuation  reserve is  appropriate  under the
current circumstances.

     The  amount of the  deferred  tax  assets  considered  realizable  could be
reduced  in the  future  if  estimates  of  future  taxable  income  during  the
carryforward  period are reduced.

     The  recorded  deferred  tax asset  includes an  increase to the  valuation
allowance of $1,866,000 during the fiscal year ended May 31, 2005.

     The Company's deferred tax assets are summarized as follows:
<TABLE>
<CAPTION>
                                                       2005               2004               2003
                                                  ---------------    ---------------    ---------------
<S>                                                 <C>                <C>                <C>
Net operating loss and other carryforwards          $16,489,000        $14,468,000        $13,368,000
      Accrued compensation                               68,000            118,000            153,000
      Bad debts                                         134,000            238,000            244,000
      Other                                           1,665,000          1,666,000          1,439,000
                                                  ---------------    ---------------    ---------------
Total gross deferred tax assets                      18,356,000         16,490,000         15,204,000
      Valuation allowance                            (3,774,000)        (1,908,000)          (622,000)
                                                  ---------------    ---------------    ---------------
Net deferred tax assets                             $14,582,000        $14,582,000        $14,582,000
                                                  ===============    ===============    ===============
</TABLE>

     The deferred tax benefit for fiscal years May 31, 2005,  2004 and 2003 does
not include  the tax benefit  associated  with the  current  exercises  of stock
options and warrants, aggregating $0, $0, and $222,000,  respectively, which was
credited directly to additional paid-in capital.

                                      F-22

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


     At May 31,  2005,  the Company had net  operating  loss  carryforwards  for
Federal and state income tax purposes of approximately $48,498,000,  expiring at
various  dates  from 2006  through  2022.  During  fiscal  2005,  $96,516 of net
operating loss carryforwards expired, and subsequent expiration of net operating
loss carryforwards are as follows:

<TABLE>
<CAPTION>
                        Fiscal Year                    Amount
                        -------------------     --------------
                        <S>                           <C>
                        2006                          336,198
                        2007                          517,934
                        2008                          558,968
                        2009                          470,994
                        2010                        2,454,162
                        Thereafter                 44,159,560
                                                --------------
                                                  $48,497,816
                                                ==============
</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>
                                                2005                    2004                      2003
                                               Amount         %        Amount         %          Amount         %
                                           --------------- -------- -------------- --------- --------------- --------
<S>                                         <C>             <C>      <C>             <C>     <C>              <C>
Federal statutory rate                      $(1,850,626)    (34.0)   $(1,146,439)    (34.0)  $(2,185,000)     (34.0)
State taxes, net                                 39,661       0.7         50,640       1.5        34,000         .5
Permanent differences                            34,720       0.6         23,839       0.8        33,320         .5
Utilization of net operating loss                    --      --               --      --              --       --
Change in valuation allowance
  relating to operations                      1,866,000      34.3      1,286,000      38.1       622,000        9.7
Other                                           (50,094)     (0.9)      (163,400)     (4.9)     (139,008)      (2.1)
                                           --------------- -------- -------------- --------- --------------- --------
                                                $39,661       0.7        $50,640       1.5   $(1,634,688)     (25.4)
                                           =============== ======== ============== ========= =============== ========
</TABLE>

NOTE M - COMMITMENTS AND CONTINGENCIES

Employment Agreements

     In October 2003, the Company entered into an employment  agreement with its
new Chief  Financial  Officer.  The agreement,  which expires in September 2005,
provides for certain settlement benefits, including a lump-sum payment of twelve
months of base  salary in the event of a change of  control,  as  defined,  or a
termination payment in an amount equal to six months of base salary in the event
of termination without cause, as defined.

     The approximate  aggregate  minimum  compensation  obligation  under active
employment agreements at May 31, 2005, are summarized as follows:

<TABLE>
<CAPTION>
                        Fiscal Year                       Amount
                        -------------------     -----------------
                        <S>                              <C>
                        2006                             $40,625
                                                =================
</TABLE>

                                      F-23
<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003

Leases

     The Company  leases  additional  warehouse  space  under two  noncancelable
operating  leases,  of which one expires on October 31,  2005,  and the other on
September  30, 2006.  Rent  expense was  $93,000,  $72,000 and $99,000 in fiscal
2005, 2004 and 2003, respectively.

     Approximate   aggregate  minimum  annual   obligations  under  these  lease
agreements  and  other  equipment  leasing  agreements  at  May  31,  2005,  are
summarized as follows:
<TABLE>
<CAPTION>
                        Fiscal Year                    Amount
                        -------------------     --------------
                        <S>                            <C>
                        2006                           62,329
                        2007                           14,238
                                                --------------
                                                      $76,567
                                                ==============
</TABLE>
Litigation

     The  Company is  currently,  and has in the past  been,  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.

     In June 2001, an action was commenced in the New York Supreme Court, Nassau
County,  against  the  Company  by the former  holder of a warrant  to  purchase
100,000  shares of the Company's  stock seeking  undefined  damages based upon a
claim that the Company  breached an  agreement  to  register  the common  shares
underlying  the warrant at the "earliest  practicable  date" after due demand by
the warrant  holder had been made.  In October  2002,  the Company  settled this
matter for  $600,000  through the  execution  of an  agreement  that enables the
Company to satisfy this obligation over a four-year  period  ($200,000 in fiscal
2003,  $66,500 in fiscal 2004,  $133,000  each in fiscal years 2005 and 2006 and
$66,500 in fiscal 2007). Accordingly,  the Company recorded a $600,000 charge to
operations  in fiscal 2003. In December  2002,  the Company paid $200,000 to the
warrant holder pursuant to the terms of the settlement agreement.

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 2005,
2004 and 2003, the Company made  discretionary  contributions  of  approximately
$38,000,  $35,535 and $35,000,  respectively,  to match a percentage of employee
contributions.

                                      F-24

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


NOTE N - 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, 2005 and 2004.

<TABLE>
<CAPTION>

                                                               Three months ended
                        --------------------------------------------------------------------------------------------------
(in 000s except          May 31,     Feb. 28,     Nov. 30,     Aug. 31,     May 31,     Feb. 29,    Nov. 30,    Aug. 31,
Earnings (loss) per        2005        2005         2004         2004         2004        2004        2003        2003
share data)                                                                                           (a)
----------------------- ----------- ----------- ------------- ------------ ----------- ----------- ----------- -----------
<S>                       <C>         <C>          <C>          <C>          <C>         <C>         <C>         <C>
Revenues                  $3,848      $2,964       $3,462       $4,821       $5,927      $5,950      $4,903      $5,427
Gross Profit              $2,344      $1,800       $2,288       $3,160       $3,903      $4,017      $3,210      $3,488
Net Loss                 $(1,001)    $(2,027)     $(1,610)       $(924)       $(759)      $(310)    $(2,087)      $(267)
Loss per
  share    - basic        $(0.02)     $(0.03)      $(0.03)      $(0.02)      $(0.01)     $(0.01)     $(0.04)     $(0.00)
           - diluted      $(0.02)     $(0.03)      $(0.03)      $(0.02)      $(0.01)     $(0.01)     $(0.04)     $(0.00)
Weighted average
  common shares
  outstanding
           - basic        58,553      58,553       58,553        58,532      58,384      57,887      57,828      57,827
           - diluted      58,553      58,553       58,553        58,532      58,384      57,887      57,828      57,827

(a)  Net loss for the second  quarter of fiscal 2004 was  adversely  affected by
     the write-off of  approximately  $680 related to significant  uncertainties
     related  to the  ability  of a major  customer  to  satisfy  its  financial
     obligations to the Company, (see Note E).
</TABLE>

NOTE O - SUBSEQUENT EVENT

     On July 19, 2005, we entered into a Securities Purchase Agreement that will
provide 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").  We received  $1.75 million or 70% of the gross  proceeds on
July 19, 2005 and the  balance of  $750,000 is expected to be received  upon the
filing of the registration  statement (see below).  The agreement provides for a
private placement of 25,000 shares of Vasomedical's  Series D Preferred Stock at
$100 per share.  The preferred stock is 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  registering  the shares of common  stock that
could be acquired through  conversion of preferred  shares,  Vasomedical may, at
its option, require the holders to convert all their preferred stock into common
shares if the closing  price for the common  stock for the  preceding 20 trading
days has been greater than $1.30 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.  Conversion  of the  preferred  stock and exercise of the warrants are
subject to limitation  such that the  beneficial  ownership of the Investors and
their affiliates shall not exceed 9.99% of the common stock  outstanding.  Under
the terms of a Registration Rights Agreement with the Investors,  Vasomedical is
to file a registration  statement with the Securities and Exchange Commission by
September 2, 2005, for the shares of common stock underlying the preferred stock
and warrants.

     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 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.

     An event of default  occurs if we fail to timely pay the dividend,  fail to
timely file a registration  statement for the shares of common stock  underlying
the preferred  shares and warrants,  or have not obtained  effectiveness  of the
registration  statement by December 1, 2005, among other specified  occurrences.
Upon an  event  of  default,  the  price at which  the  preferred  stock  may be
converted into common stock is reduced from 85 percent to 75 percent of the then
current  volume  weighted  average  market  price per  share,  but not more than
$0.6606 or less than $0.40 per share (the "Floor Price").  In the event that our
quarterly  gross revenues are less than  $2,500,000,  then the Floor Price shall
automatically  reduce to $0.30. In addition,  the holders of the preferred stock
have the  right  to be paid  first  from  the  assets  of  Vasomedical  upon any
dissolution  or liquidation of the company.

                                      F-25

<PAGE>
                       Vasomedical Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                           May 31, 2005, 2004 and 2003


     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.


                                      F-26
<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                         Balance at end
                                                period         expenses      accounts       Deductions         of period
------------------------------------------- --------------- --------------- ------------ ------------------ -----------------

Allowance for doubtful accounts
<S>              <C> <C>                          <C>              <C>              <C>           <C>               <C>
  Year ended May 31, 2005                         $699,203         $11,084          $--    (a)    $315,595          $394,692
  Year ended May 31, 2004                         $768,629        $616,759          $--    (a)    $686,185          $699,203
  Year ended May 31, 2003                       $1,099,687      $1,227,324          $--    (a)  $1,558,382          $768,629

Valuation Allowance- Financing Receivables
  Year ended May 31, 2005                              $--             $--          $--                $--               $--
  Year ended May 31, 2004                         $244,994        $680,000          $--    (b)    $924,994               $--
  Year ended May 31, 2003                         $718,879                          $--    (b)    $473,885          $244,994

Reserve for excess and obsolete inventory
  Year ended May 31, 2005                         $399,477        $166,672          $--                $--          $566,149
  Year ended May 31, 2004                         $280,477        $119,000          $--                $--          $399,477
  Year ended May 31, 2003                         $180,477        $100,000          $--                $--          $280,477

Valuation Allowance - Deferred Tax Asset
  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
  Year ended May 31, 2003                              $--        $622,000          $--                $--          $622,000

Provision for warranty obligations
  Year ended May 31, 2005                         $244,917         $27,000          $--    (c)    $153,584          $118,333
  Year ended May 31, 2004                         $788,000        $164,000          $--    (c)    $707,083          $244,917
  Year ended May 31, 2003                         $991,000        $724,000          $--    (c)    $927,000          $788,000

(a)  accounts  receivable  written  off,  net  of  $10,000,  $0 and  $15,000  in
     recoveries in fiscal years 2005, 2004 and 2003, respectively.
(b)  financing receivables written off
(c)  warranty claims paid
</TABLE>


                                      S-1