Virtual Radiologic (VRAD) 10-Q 2010 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to

Commission File Number 001-33815

Virtual Radiologic Corporation

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	27-0074530 (IRS Employer Identification No.)
11995 Singletree Lane, Suite 500 Eden Prairie, Minnesota (Address of principal executive offices)	55344 (Zip code)

(952) 595-1100
(Registrant’s telephone number, including area code)

     Indicate by 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. Yesþ  Noo

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filero Accelerated filero Non-accelerated filero(Do not check if a smaller reporting company) Smaller reporting companyþ

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

     As of April 26, 2010, 16,268,944 shares of the registrant’s common stock were outstanding.

TABLE OF CONTENTS

Part I — Financial Information
Item 1. Consolidated Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	25
Item 4. Controls and Procedures	25
Part II — Other Information
Item 1. Legal Proceedings	26
Item 6. Exhibits	26
Signatures	27
EX-31.1
EX-31.2
EX-32.1
EX-32.2

2

PART I — Financial Information

ITEM 1. Consolidated Financial Statements

Virtual Radiologic Corporation

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Contents

	Page
Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009	4
Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009	5
Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2010 and the year ended December 31, 2009	6
Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009	7
Notes to Consolidated Financial Statements	8

3

VIRTUAL RADIOLOGIC CORPORATION

CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share data)

	As of			As of
	March 31,			December 31,
	2010			2009
Assets
Current assets:
Cash and cash equivalents	$	52,392		$	50,163
Restricted cash		1,751			1,751
Accounts receivable, net		18,451			17,384
Prepaid expenses and other current assets		2,633			2,768
Total current assets		75,227			72,066
Property and equipment, net		12,371			13,489
Intangible assets, net		4,092			3,952
Goodwill		871			858
Medical malpractice excess loss reserves receivable		974			1,008
Deferred tax asset		3,401			3,084
Other assets		5			5
Total assets	$	96,941		$	94,462
Liabilities and Stockholders’ Equity
Current liabilities:
Accrued professional services compensation expense	$	5,838		$	5,719
Accrued sales, general and administrative compensation expense		2,019			4,087
Current deferred tax liability		—			1,089
Current taxes payable		2,741			1,635
Medical malpractice loss reserves, current		410			468
Accounts payable and other current liabilities		2,893			2,076
Total current liabilities		13,901			15,074
Deferred tenant lease allowance		2,427			2,491
Medical malpractice loss reserves		6,462			5,101
Medical malpractice excess loss reserves		974			1,008
Other liabilities		1,398			1,454
Total liabilities		25,162			25,128
Commitments and contingencies (Note 5)
Stockholders’ equity:
Common stock, $.001 par value; 100,000,000 shares authorized as of March 31, 2010 and December 31, 2009; 16,245,994 and 16,054,829 shares issued and 15,964,860 and 15,928,661 shares outstanding as of March 31, 2010 and December 31, 2009, respectively		17			17
Additional paid-in capital		102,620			102,118
Treasury stock at cost, 1,095,980 and 1,095,490 shares as of March 31, 2010 and December 31, 2009, respectively		(9,312	)		(9,306	)
Accumulated deficit		(21,528	)		(23,482	)
Accumulated other comprehensive loss		(18	)		(13	)
Total stockholders’ equity		71,779			69,334
Total liabilities and stockholders’ equity	$	96,941		$	94,462

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

4

VIRTUAL RADIOLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)

	Three Months Ended
	March 31,
	2010			2009
Revenue	$	30,813		$	28,568
Operating costs and expenses:
Professional services		15,124			13,766
Sales, general and administrative		10,641			11,066
Depreciation and amortization		1,872			1,450
Total operating costs and expenses		27,637			26,282
Operating income		3,176			2,286
Other income (expense):
Interest income		45			57
Interest expense		(1	)		(1	)
Total other income		44			56
Income before income tax expense		3,220			2,342
Income tax expense		1,266			950
Net income	$	1,954		$	1,392
Earnings per common share:
Basic	$	0.12		$	0.09
Diluted	$	0.12		$	0.09
Weighted average common shares outstanding:
Basic		15,949			15,863
Diluted		16,305			16,240

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

5

VIRTUAL RADIOLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(unaudited)

(in thousands)

															Accumulated
						Additional									Other						Total
	Common Stock					Paid-In			Treasury			Accumulated			Comprehensive			Non-controlling			Stockholders’
	Shares			Amount		Capital			Stock			Deficit			Loss			Interest			Equity
Balance at December 31, 2008		15,849		$	17	$	95,881		$	(8,000	)	$	(31,397	)	$	(6	)	$	22		$	56,517
Net income		—			—		—			—			7,915			—			—			7,915
Other comprehensive income
Foreign currency translation adjustments		—			—		—			—			—			(7	)		—			(7	)
Total comprehensive income																						7,908
Stock-based compensation for independent contractor physicians		—			—		787			—			—			—			—			787
Stock-based compensation for employees and directors		—			—		2,420			—			—			—			—			2,420
Stock option exercises		230			—		219			—			—			—			—			219
Excess tax benefits from exercises of stock options		—			—		2,811			—			—			—			—			2,811
Non-controlling interest		—			—		—			—			—			—			(22	)		(22	)
Repurchases of common stock		(150	)		—		—			(1,306	)		—			—			—			(1,306	)
Balance at December 31, 2009		15,929		$	17	$	102,118		$	(9,306	)	$	(23,482	)	$	(13	)	$	—		$	69,334
Net income		—			—		—			—			1,954			—			—			1,954
Other comprehensive income
Foreign currency translation adjustments		—			—		—			—			—			(5	)		—			(5	)
Total comprehensive income																						1,949
Stock-based compensation for independent contractor physicians		—			—		11			—			—			—			—			11
Stock-based compensation for employees and directors		—			—		577			—			—			—			—			577
Issuance of common stock from equity awards		36			—		10			—			—			—			—			10
Tax shortfall from exercises of stock options		—			—		(96	)		—			—			—			—			(96	)
Repurchases of common stock					—		—			(6	)		—			—			—			(6	)
Balance at March 31, 2010		15,965		$	17	$	102,620		$	(9,312	)	$	(21,528	)	$	(18	)	$	—		$	71,779

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

6

VIRTUAL RADIOLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

	Three Months Ended
	March 31,
	2010			2009
Cash flows from operating activities:
Net income	$	1,954		$	1,392
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for doubtful accounts and sales allowances		243			535
Depreciation and amortization		1,872			1,450
Medical malpractice loss reserves		1,361			1,300
Stock-based compensation for independent contractor physicians		11			(143	)
Stock-based compensation for employees and directors		577			721
Deferred income taxes		(1,960	)		23
Other, net		(48	)		16
Changes in operating assets and liabilities:
Accounts receivable		(1,310	)		(1,142	)
Prepaid expenses and other assets		673			517
Accrued expenses		(1,822	)		1,134
Accounts payable and other liabilities		1,690			880
Net cash provided by operating activities		3,241			6,683
Cash flows from investing activities:
Purchases of property and equipment		(606	)		(2,230	)
Cash paid for acquisition (see Note 2)		(400	)		—
Restricted cash		—			(1,050	)
Other, net		—			5
Net cash used in investing activities		(1,006	)		(3,275	)
Cash flows from financing activities:
Payments on capital lease		(10	)		—
Proceeds from stock option exercises		10			22
Excess tax benefits from exercises of stock options		—			461
Repurchases of common stock		(6	)		(116	)
Net cash (used in) provided by financing activities		(6	)		367
Net increase in cash and cash equivalents		2,229			3,775
Cash and cash equivalents:
Beginning of period		50,163			19,180
End of period	$	52,392		$	22,955
Supplemental disclosure of cash flow information:
Cash paid (received) for income taxes, net	$	2,113		$	(538	)

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

7

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

1. Business Overview and Basis of Presentation

     Virtual Radiologic Corporation, or vRad, is a national radiology practice working in partnership with radiologists and hospitals to optimize radiology’s pivotal role in the delivery of patient care. Enabled by next-generation technology, vRad’s collaborative partnerships enhance productivity and deliver demonstrated quality outcomes that help lower the overall cost of care. vRad’s 144 affiliated radiologists serve over 1,200 facilities (approximately 21% of U.S. hospitals), reading more than 2.6 million interpretations annually.

     Virtual Radiologic Professionals, LLC, or VRP, is the Company’s affiliated physician-owned medical practice that contracts with independent contractor physicians for the provision of their services to fulfill customer contracts held by vRad or the “Professional Corporations,” comprised of Virtual Radiologic Professionals of California, P.A., Virtual Radiologic Professionals of Illinois, S.C., Virtual Radiologic Professionals of Michigan, P.C., Virtual Radiologic Professionals of Minnesota, P.A., Virtual Radiologic Professionals of New York, P.A. and Virtual Radiologic Professionals of Texas, P.A. As of March 31, 2010, each of these entities was a professional corporation with one stockholder, who was also an officer and a director of vRad and the sole equity owner of VRP. The Professional Corporations hold customer contracts in certain states to comply with corporate practice of medicine laws in such states. VRP and the Professional Corporations are collectively referred to as the “Affiliated Medical Practices.”

     vRad also has two wholly-owned and consolidated subsidiaries, Virtual Radiologic Limited, or VRL, and vRad Professional Insurance Ltd., or VPIL. VRL was formed under the laws of England and Wales and is located in London, England. VRL was formed to facilitate the international expansion of the Company’s business. VPIL was formed as an exempted company in the Cayman Islands to insure the Company’s self-insured retention under its medical malpractice insurance policy.

     The term “Company” as used in this report refers to vRad, its Affiliated Medical Practices, VRL and VPIL.

     Interim Consolidated Financial Statements

     The Company has prepared the unaudited interim consolidated financial statements and related notes thereto in accordance with generally accepted accounting principles in the United States of America, or GAAP, and the rules and regulations of the Securities and Exchange Commission, or the SEC, for interim financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These interim financial statements reflect all adjustments consisting of normal recurring accruals, which, in the opinion of management, are necessary to present fairly the Company’s consolidated financial position, the results of its operations and its cash flows for the interim periods. The nature of the Company’s business is such that the results of any interim period may not be indicative of the results to be expected for the entire year.

     These interim consolidated financial statements should be read in conjunction with the consolidated annual financial statements and the notes thereto included in the Company’s 2009 Annual Report on Form 10-K filed with the SEC on February 18, 2010. The December 31, 2009 balance sheet data has been derived from audited financial statements as of that date, but does not include all note disclosures required by GAAP. However, the Company believes that the disclosures presented are adequate to make the information presented not misleading.

8

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

     Significant Accounting Policies and Estimates

     The Company’s significant accounting policies and estimates are described in Note 2,Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements and in Item 7,Management’s Discussion and Analysis of Financial Condition and Results of Operationsincluded in the Annual Report on Form 10-K for the fiscal year ended December 31, 2009. There have been no significant changes in the Company’s significant accounting policies or critical accounting estimates during the quarter ended March 31, 2010.

     Principles of Consolidation

     The Company consolidates its financial results in accordance with accounting guidance on consolidations and variable interest entities, which requires a primary beneficiary to consolidate entities determined to be variable interest entities, or VIEs. The Affiliated Medical Practices were created as the Company’s business expanded, for the purpose of facilitating compliance with corporate practice of medicine laws in various states. The management of vRad was involved significantly in the design and creation of the Affiliated Medical Practices and, with the exception of rendering medical judgments, controls their continuing operations through rights contained in management service agreements, including the unilateral right to appoint a successor owner of the Affiliated Medical Practices, to reset the management fee on an annual basis and to restrict the distribution of any accumulated earnings to the equity owners of the Affiliated Medical Practices. The management service agreements that exist between the entities are perpetual agreements that are not cancellable by the owner of the Affiliated Medical Practices other than for gross negligence, fraud or other illegal acts by vRad, and they were not intended to cause a party other than vRad to bear any economic risk or reward. The management fees contained in these agreements are generally evaluated on an annual basis, for purposes of resetting vRad’s financial interests in the Affiliated Medical Practices, and to ensure that no party other than vRad bears any economic risk or reward. As a result, the Company has determined that the Affiliated Medical Practices are VIEs and that vRad is the primary beneficiary of such VIEs. Although vRad holds no equity ownership in the VIEs, as a result of the rights described above, the Company has determined that vRad has a controlling financial interest in the Affiliated Medical Practices and that vRad should not allocate any of the residual net earnings or losses of these entities to the legal equity owners.

     Prior to January 1, 2009, the Company allocated any accumulated earnings of the Affiliated Medical Practices to the equity owners of the Affiliated Medical Practices through non-controlling interest in the consolidated financial statements. However, in accordance with accounting guidance for non-controlling interests in consolidated financial statements, the Company has determined that vRad has a controlling financial interest in the VIEs which requires full consolidation of the Affiliated Medical Practices. As a result, during the year ended December 31, 2009, the Company recorded an adjustment of approximately $22,000 to eliminate the previously recognized non-controlling interest in the VIEs. Due to the immaterial amount of previously recognized non-controlling interest, prior periods were not adjusted.

     The effect of the VIEs’ consolidation on the Company’s Consolidated Balance Sheet at March 31, 2010 was an increase in the Company’s assets and liabilities of approximately $8.2 million and $6.3 million, respectively. At December 31, 2009, as a result of consolidating the VIEs, the Company’s assets and liabilities increased by approximately $8.7 million and $6.0 million, respectively. For the three months ended March 31, 2010 and 2009, the revenue of the VIEs represented approximately 42%, or $12.8 million, and 46%, or $13.3 million of the consolidated revenue of the Company, respectively.

     As of March 31, 2010 and December 31, 2009, and for the three months ended March 31, 2010 and 2009, the financial statements of vRad have been presented on a consolidated basis to include its variable interests in the Affiliated Medical Practices, as well as VRL and VPIL, vRad’s wholly-owned subsidiaries.

     The results of the Company’s operations are based on a single reportable segment for purposes of presenting financial information in accordance with accounting guidance on segment reporting.

9

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

     Revenue Recognition and Accounts Receivable

     The Company generates substantially all of its revenue from radiology services it provides to its customers on a fee-for-service basis. The Company provides these services pursuant to contracts that have a one or two-year initial term and automatically renew for successive one-year terms unless terminated by the customer or by the Company. The amount that the Company charges for its radiology services varies by customer and is based upon a number of factors, including the hours of coverage, the number of reads, whether the reads are preliminary reads or final reads, and the technical and administrative services provided. These services are billed to the Company’s customers with whom it contracts directly. Revenues are recognized when delivery of a service is completed by the Company’s independent contractor physicians and collectability is reasonably assured.

     The Company maintains an allowance for doubtful accounts, which is comprised of a general reserve and specific reserves for potentially uncollectable amounts based on historical bad debts. General reserves are determined based upon a percentage of outstanding aged receivables. The percentage used to establish general reserves is based on historical collection experience and may fluctuate as collections experience changes over time. The general reserve balances have historically increased as revenue and receivable amounts have increased and the Company expects that trend to continue for the foreseeable future. In determining the amount of the specific reserve, the Company reviews the accounts receivable for customers who are past due to identify specific customers with known disputes or collectability issues. The Company makes judgments about their creditworthiness based on collections information available and historical payment performance.

     The Company also maintains a sales allowance to reserve for potential credits issued to customers. The amount of the reserve is determined based on historical credits issued.

     The Company bills third-party payers such as Medicare, Medicaid, private insurance and/or patients directly for final interpretations provided under agreements with a small number of its customers. Services for which the Company submits billings directly to third-party payers are coded for reimbursement based upon the specific services provided, and patients are responsible for any remaining deductibles or coinsurance. Revenue is recorded for these services based on the anticipated reimbursement, net of any contractual adjustments and/or allowance for denied claims. As a result of its limited history in billing third party payers, the Company estimates the anticipated reimbursement using a combination of industry collection rates, and collection rates based on the Company’s own collection experience. These estimates are evaluated and revised on a quarterly basis as more collection data becomes available. The allowance for contractual adjustments is recorded in Revenue as a contra revenue account on the Consolidated Statements of Operations and in Accounts receivable, net, on the Consolidated Balance Sheets. Revenue related to these services is recognized when delivery of a service is completed by the Company’s independent contractor physicians and collectability is reasonably assured.

     For services which are billed directly to patients, the Company maintains an allowance for doubtful accounts for potentially uncollectable amounts based on historical industry patient collection rates.

     Recently, the Company’s customers have been impacted by the economic downturn. The Company is unable to fully predict what impact a continued economic downturn will have on customers’ ability to pay, or when general economic conditions will improve, which may impact the amount of specific reserves in future periods.

     New Accounting Standards

     Consolidation of Variable Interest Entities– On January 1, 2010, the Company adopted new guidance which requires a qualitative approach to identifying a controlling financial interest in a VIE and also requires an ongoing reassessment of whether an entity is a VIE and whether an interest in a VIE makes the holder the primary beneficiary. The adoption of this new guidance did not have a material effect on the Company’s consolidated financial position, results of operations and/or cash flows.

10

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

     Fair Value Measurements– On January 1, 2010, the Company adopted new guidance on fair value measurements for non-financial assets and liabilities. The new guidance defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. The adoption of this new guidance did not have a material effect on the Company’s consolidated financial position, results of operations and/or cash flows.

     Subsequent Events– In February 2010, the Financial Accounting Standards Board, or FASB, issued new guidance on amending certain recognition and disclosure requirements for subsequent events. The new guidance clarifies existing guidance for evaluating subsequent events and removes the requirement for SEC filers to disclose the date through which subsequent events have been evaluated. The adoption of this new guidance did not have a material effect on the Company’s consolidated financial position, results of operations and/or cash flows.

2. Goodwill and Other Intangible Assets, Net

     During the quarter ended March 31, 2010, the Company acquired certain assets of a radiology practice for total cash consideration of $400,000. In connection with this acquisition, the Company recorded goodwill of $14,000 and $386,000 of customer relationships.

     Goodwill

     The Company records acquired assets, including identifiable intangible assets and liabilities, at their respective fair values, recording goodwill as the excess of cost over the fair value of the net assets acquired. Goodwill is not amortized, but instead tested for impairment at least annually, or more frequently if events or changes in circumstances indicate potential impairment. The Company’s annual test is performed during the second quarter and the results of the test completed as of June 30, 2009 indicated the fair value of the reporting unit substantially exceeded its carrying value, and therefore, goodwill was not impaired. As of March 31, 2010, the Company has determined that no events or changes in circumstances have indicated potential impairment. There were no accumulated impairment losses as of March 31, 2010 and December 31, 2009.

     Intangible Assets, Net

	As of							As of
	March 31, 2010							December 31, 2009
			Accumulated							Accumulated
	Original Cost		Amortization			Carrying Value		Original Cost		Amortization			Carrying Value
	(in thousands)
Patent application costs	$	347	$	(86	)	$	261	$	347	$	(80	)	$	267
Non-compete agreements		298		(292	)		6		298		(255	)		43
Customer relationships		5,354		(1,529	)		3,825		4,968		(1,326	)		3,642
Intangible assets, net	$	5,999	$	(1,907	)	$	4,092	$	5,613	$	(1,661	)	$	3,952

     The Company records amortization related to patents and non-compete agreements on a straight-line basis over their estimated useful lives of 15 years and 2 years, respectively. The Company records amortization related to customer relationships over their estimated useful lives between 3 and 10 years based on the expected future economic benefits of those customer relationships on an accelerated basis. Amortization expense related to intangible assets was approximately $246,000 and $280,000 for the three months ended March 31, 2010 and 2009, respectively.

     The Company continually reviews events and changes in circumstances related to its financial performance and economic environment for factors that would provide evidence of potential impairment or that may warrant a revision to the remaining periods of amortization of its intangible assets. If impairment indicators are identified, the Company would test for impairment using undiscounted cash flows as the basis for measuring

11

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

the fair value of its intangible assets. As of March 31, 2010, the Company has determined that no events or changes in circumstances have indicated potential impairment.

     As of March 31, 2010, future estimated amortization expense related to intangible assets was as follows:

	Amount
	(in thousands)
Nine months ending December 31, 2010	$	690
Year ending December 31, 2011		864
Year ending December 31, 2012		699
Year ending December 31, 2013		498
Year ending December 31, 2014		393
Thereafter		948
Total	$	4,092

     This future amortization expense is an estimate. Actual amounts may vary from these estimated amounts due to additional intangible asset acquisitions, potential impairment, accelerated amortization or other events.

3. Stock-Based Compensation

     vRad Equity Incentive Plan

     vRad’s Amended and Restated Equity Incentive Plan provides for the grant of incentive stock options, nonqualified stock options, stock appreciation rights and restricted stock to the Company’s officers, employees and independent contractor physicians. Options granted under the plan have a maximum duration of ten years and typically vest in five years or less in a manner approved by the Board of Directors. As of March 31, 2010, there were 517,774 shares available for issuance under the vRad Equity Incentive Plan.

     Stock-Based Compensation Costs

     Employee Stock-Based Compensation.Stock-based compensation expense related to employee and director equity awards was approximately $577,000 and $721,000 for the three months ended March 31, 2010 and 2009, respectively. Included in stock-based compensation expense for the three months ended March 31, 2009 was $182,000 related to the accelerated vesting of certain stock option awards. There were no expenses incurred during the three months ended March 31, 2010 associated with modifications to the terms of existing equity awards. Employee and director stock-based compensation expense is included in Sales, general and administrative expenses in the Consolidated Statements of Operations.

     During the three months ended March 31, 2010 and 2009, the Company issued 169,666 and 88,000 restricted stock awards, respectively, to certain employees and directors. There were no stock options issued to employees or directors during the three months ended March 31, 2010. During the three months ended March 31, 2009, 375,000 stock options were issued to certain employees and directors.

     As of March 31, 2010, unrecognized stock-based compensation related to unvested employee stock options and restricted stock awards granted on or after January 1, 2006, was approximately $5.4 million, net of estimated forfeitures. These costs are to be recognized over a weighted average period of approximately 2.8 years.

     Physician Stock-Based Compensation.The Company recorded physician stock-based compensation expense of approximately $11,000 and income of approximately $143,000 for the three months ended March 31, 2010 and 2009, respectively. Physician stock-based compensation expense is included in Professional services expense in the Consolidated Statements of Operations.

12

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

     During the three months ended March 31, 2010 and 2009, the Company issued 11,200 and zero restricted stock awards, respectively, to certain independent contractor physicians. There were no stock options issued to independent contractor physicians during the three months ended March 31, 2010 and 2009.

     Stock Option Activity

     Stock option activity for employees, directors and independent contractor physicians during the three months ended March 31, 2010 was as follows:

				Weighted		Weighted
				Average		Average
				Exercise Price		Contractual Life
	Outstanding			Per Share		(in years)
Balance at December 31, 2009(1)		2,098,400		$	11.31		—
Granted		—			—		—
Exercised		(15,689	)		3.25		—
Forfeited/Cancelled/Expired		(77,789	)		12.18		—
Balance at March 31, 2010		2,004,922			11.34		5.81
Options vested and expected to vest at March 31, 2010(2)		1,976,700			11.32		5.82
Exercisable at March 31, 2010		1,045,632			10.24		5.06

(1)	The number of options outstanding includes 120,000 options granted in May 2007 to members of vRad’s Board of Directors that were not issued pursuant to the vRad Equity Incentive Plan.
(2)	Options expected to vest reflect an estimated forfeiture rate.

     Restricted Stock Award Activity

     Restricted stock award activity for employees, directors and independent contractor physicians during the three months ended March 31, 2010 was as follows:

				Weighted		Weighted
				Average		Average
				Fair Value		Vesting Period
	Outstanding			Per Share		(in years)
Balance at December 31, 2009		126,168		$	9.53		—
Granted		180,866			10.58		—
Vested		(21,000	)		8.70		—
Forfeited/Cancelled/Expired		(4,900	)		9.14		—
Balance at March 31, 2010		281,134			10.18		3.59
Awards vested and expected to vest at March 31, 2010(1)		274,642			10.18		3.59

⁽¹⁾  Awards expected to vest reflect an estimated forfeiture rate.

4. Stock Repurchase Program

     In March 2009, vRad’s Board of Directors authorized the repurchase of up to $5.0 million of vRad’s outstanding common stock. Repurchases may take place in the open market, or pursuant to negotiated or block transactions in accordance with applicable SEC guidelines and regulations, including plans intended to comply with Rule 10b5-1 under the Securities Exchange Act. During the three months ended March 31, 2010, vRad did not repurchase any shares of common stock under the stock repurchase program. As of March 31, 2010, vRad had $3.7 million remaining under the $5.0 million share repurchase program.

13

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

5. Commitments and Contingencies

     On December 7, 2007, the Company entered into an agreement to lease approximately 82,000 square feet of space in Eden Prairie, Minnesota, to consolidate its corporate headquarters. The lease commenced on March 2, 2009 and expires on August 31, 2019. In conjunction with the lease, the Company was entitled to a tenant improvement allowance of approximately $2.7 million and the Company recorded the allowance in leasehold improvements and deferred tenant lease allowance. The amounts for leasehold improvements and deferred tenant lease allowance are recorded in Property and equipment, net and Deferred tenant lease allowance on the Consolidated Balance Sheet as of December 31, 2009. In addition, the lease arrangement contains a rent escalation clause and the related lease expenses are recognized on a straight-line basis over the term of the lease. Deferred rent in the amount of $859,000 and $852,000 associated with this lease is included in Other liabilities on the Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009, respectively.

     Professional Liability Coverage

     The Company’s business entails an inherent risk of claims of medical malpractice against its independent contractor physicians and itself. The Company contracts and pays premiums for professional liability insurance that indemnifies it and its independent contractor physicians for losses incurred related to medical malpractice litigation. The Company maintains professional liability insurance policies with a third-party insurer on a claims-made basis, subject to a self-insured retention, deductibles, exclusions and other restrictions. The Company’s self-insured retention under its professional liability insurance program is insured by VPIL, its wholly-owned captive insurance subsidiary. The Company records liabilities for self-insured amounts and claims incurred but not reported, or IBNR, in combination with its own loss history, based on an actuarial valuation using historical loss patterns. The actuarial analysis utilizes industry loss data as a result of the Company’s limited experience.

     Insurance liabilities are necessarily based on estimates, including claim frequency and severity. An inherent assumption in such estimates is that historical loss patterns can be used to predict future loss patterns with reasonable accuracy. Because many factors can affect historical and future loss patterns, the determination of an appropriate reserve involves complex, subjective judgment, and actual results may vary significantly from current estimates. Liabilities for claims incurred but not reported are not discounted.

     The following table summarizes the activity of the Company’s medical malpractice loss reserves for the three months ended March 31, 2010:

	As of						As of
	December 31,						March 31,
	2009		Payments		Reserves		2010
			(in thousands)
Specific claims reserves	$	115	$	—	$	—	$	115
Medical malpratice loss development reserves		2,942		58		787		3,671
IBNR reserves		2,512		—		574		3,086
Total	$	5,569	$	58	$	1,361	$	6,872

     The Company believes that its insurance coverage is appropriate based upon its claims experience and the nature of its business. However, the Company cannot assure that any pending or future claim will not be successful, or if successful that it will not exceed the limits of available insurance coverage. If the self-insured retention amounts and/or other amounts that the Company is actually required to pay materially exceed the estimates that have been reserved, the Company’s financial condition, results of operations and cash flows could be materially adversely affected.

14

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

     Litigation

     The Company is from time to time subject to, and is presently involved in, other litigation or legal proceedings arising out of the ordinary course of business, including medical malpractice claims and certain employment related matters. Although the results of litigation and claims cannot be predicted with certainty, as of March 31, 2010 and December 31, 2009, the Company’s management believed that the final outcome of these matters would not have a material adverse effect on the Company’s business, consolidated financial position, results of operations or cash flows.

6. Related Party Transactions

     The Company has entered into a non-exclusive, non-transferable license agreement for the use of certain image management software from a minority stockholder of vRad. For the three months ended March 31, 2010 and 2009, the Company incurred licensing fees under this contract of approximately $74,000 and $289,000, respectively.

     The following table illustrates the revenues, expenses and cash flows that result from the management and professional service agreements between vRad, VRP and the Professional Corporations:

	Three Months Ended
	March 31,
	2010		2009
	(in thousands)
VRP professional services revenue from vRad	$	7,196	$	6,134
vRad professional services expense to VRP		7,196		6,134
VRP professional services revenue from the Professional Corporations		6,383		6,624
Professional Corporations professional services expense to VRP		6,383		6,624
vRad management fee revenue from the Professional Corporations		6,319		6,557
Professional Corporations management fee expense to vRad		6,319		6,557
Cash paid for professional services by vRad to VRP		7,196		6,134
Cash paid for professional services by the Professional Corporations to VRP		6,383		6,624
Cash paid for management fees by the Professional Corporations to vRad		6,319		6,557

     During the quarter ended March 31, 2009, the owners of VRP made the election with the Internal Revenue Service to have VRP taxed as a corporation effective January 1, 2009. Prior to that date VRP was taxed as a partnership. In conjunction with that election, vRad incurred certain compensation costs totaling approximately $279,000 for expected payments to certain current and former owners of VRP to reimburse them for taxes owed in connection with the election. These amounts are included in Sales, general and administrative expense in the Consolidated Statement of Operations for the three months ended March 31, 2009.

     During the quarter ended March 31, 2009, the Company incurred approximately $535,000 in expenses related to amounts due to its former Chairman under the Transition Agreement between the Company and the former Chairman that are included in Sales, general and administrative expenses in the Consolidated Statement of Operations. As of March 31, 2010 and December 31, 2009, zero and $105,000 of this amount was included in Other current liabilities on the Consolidated Balance Sheets.

7. Earnings Per Share

     Restricted stock awards issued during the year ended December 31, 2009 contain the right to non-forfeitable dividends and are classified as participating securities in accordance with accounting guidance on earnings per share. In 2010, the Company began issuing restricted stock awards in which recipients waive their right to non-forfeitable dividends and therefore, these restricted awards are classified as non-participating securities in accordance with accounting guidance on earnings per share.

15

VIRTUAL RADIOLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(unaudited)

     The following table presents the computation of earnings per share:

	Three Months Ended
	March 31,
	2010			2009
	(in thousands, except per share data)
Basic and Diluted Earnings per Share (Two-class Method)
Basic Earnings per Share:
Undistributed income available to common stockholders	$	1,954		$	1,392
Participating securities ownership		0.6	%		0.6	%
Participating securities interest in undistributed income	$	12		$	8
Weighted average participating securities outstanding		112			57
Basic earnings per share — participating securities	$	0.11		$	0.14
Undistributed income available to common stockholders	$	1,954		$	1,392
Common ownership		99.4	%		99.4	%
Common stockholders interest in undistributed income	$	1,942		$	1,384
Weighted average common shares outstanding		15,949			15,863
Basic earnings per share — common	$	0.12		$	0.09
Diluted Earnings per Share:
Common stockholders interest in undistributed income	$	1,942		$	1,384
Participating securities interest in undistributed income		12			8
Net income used in diluted earnings per share	$	1,954		$	1,392
Weighted average common shares outstanding		15,949			15,863
Weighted average participating securities outstanding		112			57
Common share equivalents		244	(1)		320	(1)
Shares used to compute earnings per common share — diluted		16,305			16,240
Diluted earnings per share	$	0.12		$	0.09

⁽¹⁾ The calculation of common stock equivalents excludes options and awards to purchase approximately 1.7 million and 1.8 million common shares for the three months ended March 31, 2010 and 2009, respectively, because they are antidilutive.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward-Looking Statements

     Certain statements in this quarterly report are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, in particular, statements about our plans, objectives, strategies and prospects regarding, among other things, our business and results of operations. These statements can be identified by the use of words such as “will”, “believe”, “expect,” and “anticipate” and similar terms or expressions of future expectation. These statements involve a number of risks, uncertainties and other factors that could cause actual results, performance or achievements of Virtual Radiologic Corporation to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Statements that are not historical facts and statements of expectations or future beliefs in this quarterly report on Form 10-Q are forward-looking statements that involve certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those indicated. Except as required by applicable law, we undertake no duty to update these forward-looking statements due to new information or as a result of future events.

     Factors that could cause our actual results to differ materially from those expressed or implied in such forward-looking statements include, but are not limited to, those discussed in the risk factors listed from time to time in our reports filed with the SEC, including without limitation, the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009.

     Given these risks and uncertainties, readers are cautioned not to place undue reliance on these forward-looking statements.

Overview

     Virtual Radiologic Corporation, or vRad, is a national radiology practice working in partnership with radiologists and hospitals to optimize radiology’s pivotal role in the delivery of patient care. Enabled by next-generation technology, vRad’s collaborative partnerships enhance productivity and deliver demonstrated quality outcomes that help lower the overall cost of care. vRad’s 144 affiliated radiologists serve over 1,200 facilities (approximately 21% of U.S. hospitals), reading more than 2.6 million interpretations annually.

     We continue to focus on expanding our business by acquiring new customers, gaining further penetration into the final read market and retaining our existing customer base, along with retaining and attracting additional radiologists.

     The terms “Company,” “we,” “us,” and “our” are used in this report to refer to vRad, the Affiliated Medical Practices, VRL and VPIL.

Trends in Our Business

     Our business has grown rapidly since inception, resulting in a continued trend of increased revenue, and we expect that our business will continue to grow. However, our revenue growth rate has slowed over time as the traditional “off hours” market for preliminary interpretations has matured resulting in increased competition and related pricing pressures.

     Our revenues have been affected by declines in the price per read charged to the customers to whom we provide service. We have seen an increased amount of pricing pressure from competition in our marketplace and we expect these declines in price to continue in future periods. In addition, our average price per read has been affected by growth in plain film reads as a percentage of total reads. We expect to continue to experience these shifts in modality mix as we continue to focus on further penetration into the daytime finals read market, which has a higher percentage of plain film reads.

     Professional services expense consists primarily of physician cash compensation, which has increased each year since inception, as we have added more independent contractor physicians to fulfill the increased demand for our services, and is expected to increase as our business continues to grow. Physician cash

17

compensation as a percentage of revenue has decreased over time due to increased efficiency driven by technological advancements in our distributed network infrastructure and our physician support services, and contractual revisions, but may increase as a percentage of revenue in future periods.

     Sales, general and administrative expenses consist primarily of employee compensation, information technology costs and facilities related costs. These costs have increased each year since our inception as a result of the increased cost associated with the development and maintenance of our expanding business but have decreased as a percentage of revenue. Although we continue to strategically invest in building the necessary employee and systems infrastructure required to manage our growth and enhance our services, we expect our sales, general and administrative expenses to continue to decrease as a percentage of revenue in future periods.

Results of Operations

     The following table sets forth selected Consolidated Statements of Operations data for each of the periods indicated as a percentage of revenue:

	Three Months Ended March 31,
	2010			2009
Revenue		100.0	%		100.0	%
Operating costs and expenses:
Physician cash compensation expense		43.8			43.4
Physician stock-based compensation expense (income)		0.1			(0.5	)
Medical malpractice liability expense		5.2			5.3
Total professional services		49.1			48.2
Sales, general and administrative		34.5			38.7
Depreciation and amortization		6.1			5.1
Total operating costs and expenses		89.7			92.0
Operating income		10.3			8.0
Total other income		0.1			0.2
Income before income tax expense		10.4			8.2
Income tax expense		4.1			3.3
Net income		6.3	%		4.9	%

Comparison of the Three Months Ended March 31, 2010 and March 31, 2009

     Revenue

     We generate substantially all of our revenue from radiology services that we provide to our customers on a fee-for-service basis. We provide these services pursuant to contracts that generally have a one or two-year initial term and automatically renew for successive one-year terms unless terminated by the customer or by us. The amount that we charge for our radiology services varies by customer and is based upon a number of factors, including the hours of coverage, the number of reads, whether the reads are preliminary reads or final reads, and the technical and administrative services provided. These services are primarily billed to our customers with whom we contract directly. Revenues are recognized when delivery of a service is completed by our independent contractor physicians and collectability is reasonably assured.

     We also bill third-party payers such as Medicare, Medicaid, private insurance and/or patients directly for final interpretations provided under agreements with a small number of our customers. Services for which we submit billings directly to third-party payers are coded for reimbursement based upon the specific services provided, and patients are responsible for any remaining deductibles or coinsurance. Revenue is recorded for these services based on the anticipated reimbursement, net of any contractual adjustments and/or allowance for denied claims. As a result of our limited history in billing third party payers, we estimate the anticipated reimbursement using a combination of industry collection rates, and collection rates based on our own collection experience. These estimates are evaluated and revised on a quarterly basis as more collection data becomes available. Revenue related to these services is recognized when delivery of a service is completed by our independent contractor physicians and collectability is reasonably assured. The allowance for contractual

18

adjustments is recorded in Revenue as a contra revenue account on the Consolidated Statements of Operations and in Accounts receivable, net, on the Consolidated Balance Sheets.

Key Revenue Metrics

	Three months ended March 31,
	2010			2009			% change
Revenue (in thousands)	$	30,813		$	28,568			8	%
Reads		700,443			613,117			14	%
Year-over-year change in price per read		(6	%)		(5	%)
Same site volume growth(1)		5	%		2	%
Percentage of read volume from:
Final reads		32	%		27	%
Preliminary reads		68	%		73	%
Customers		658			625			5	%
Facilities		1,205			1,050			15	%
Percentage of U.S. hospitals served		21	%		17	%

⁽¹⁾ Same site volume growth measures the percentage increase in the number of reads over the comparable prior period generated by a facility that has been under contract for at least three months at the beginning of the measurement period and remains a customer throughout that period.

     The increase in revenue for the three months ended March 31, 2010, as compared to the prior year period, resulted primarily from an increase in the number of customers to whom we provided services and increased volume from existing customers, partially offset by declines in our average price per read, which were primarily the result of continued pricing pressures in our marketplace, and the impact of changes in modality mix.

     Operating Costs and Expenses

     Operating costs and expenses are comprised of professional services, sales, general and administrative expenses and depreciation and amortization.

     Professional Services

     Professional services expense is comprised primarily of physician cash compensation. Physician cash compensation expense includes the fees paid to our independent contractor physicians for providing diagnostic interpretation services to our customers. We compensate our independent contractor physicians using a formula that includes a base level of compensation plus additional amounts for the number and type of reads performed. We recognize physician cash compensation expense in the month in which our independent contractor physicians perform the reads for our customers.

     Medical malpractice liability expense consists primarily of incurred but not reported, or IBNR, loss reserves, claims-made loss development reserves related to our self-insured retention, and premiums paid for third-party medical malpractice insurance. We recognize loss development and IBNR loss reserves based on actuarial analyses performed during the policy term, and amortize medical malpractice liability insurance premiums over the term of the policy to which they relate. Professional services expense also includes physician stock-based compensation which is based on the fair value of our common stock at the close of each reporting period.

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Key Professional Service Metrics

	Three Months Ended
	March 31,
	2010		2009			% Change
	(dollars in thousands)
Physician cash compensation expense	$	13,504	$	12,402			9	%
Physician stock-based compensation expense (income)		11		(143	)		(108	%)
Medical malpractice liability expense		1,609		1,507			7	%
Total professional services	$	15,124	$	13,766			10	%
Radiologists providing services		144		134			7	%
Average diagnostic cash compensation per read	$	19.16	$	20.09

     The increase in physician cash compensation expense for the three months ended March 31, 2010, as compared to the prior year period, was primarily the result of additional independent contractor physicians providing services and an increase in read volume. This increase was partially offset by a decline in average diagnostic cash compensation per read driven by increased efficiency from technological advancements and physician support services, and contractual revisions. Physician stock-based compensation is based on the value of our common stock, which increased during the three months ended March 31, 2010, as compared to the prior year period.

     Sales, General and Administrative

     Sales, general and administrative expenses include employee compensation, information technology costs and facilities related costs.

     The 4% decrease in sales, general and administrative expenses for the three months ended March 31, 2010, compared to the prior year period, included decreases in software transactional costs and employee stock-based compensation of approximately $215,000 and $140,000, respectively, and a $420,000 decrease resulting from a payment to our former Chairman under the Transition Agreement between us and our former Chairman during the three months ended March 31, 2009. These decreases were partially offset by an increase of approximately $380,000 in facility costs, primarily from additional rent and utilities costs associated with our new headquarters facility.

     Depreciation and Amortization

     Increases in depreciation and amortization expense during the three months ended March 31, 2010 and 2009, were primarily the result of additional technology and other capital equipment purchased for our operations and new corporate headquarters.

     Income Tax Expense

     Income tax expense was approximately $1.3 million and $950,000 for the three months ended March 31, 2010 and 2009, respectively. The increase was a result of higher pre-tax income for vRad of approximately $3.2 million for the three months ended March 31, 2010, compared to approximately $2.3 million for the same period in 2009, partially offset by a decline in the effective tax rate to 39.3% for the three months ended March 31, 2010, compared to 40.6% for the same period in 2009.

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Liquidity and Capital Resources

     Cash and Cash Equivalents

     Our financial position included cash and cash equivalents of $52.4 million and $23.0 million as of March 31, 2010 and 2009, respectively. The reported changes in cash and cash equivalents for the three months ended March 31, 2010 and 2009 are summarized below:

	Three Months Ended
	March 31,
	2010			2009
	(in thousands)
Net cash provided by operating activities	$	3,241		$	6,683
Net cash used in investing activities		(1,006	)		(3,275	)
Net cash (used in) provided by financing activities		(6	)		367
Net increase in cash and cash equivalents	$	2,229		$	3,775

     Cash Flows from Operating Activities

     Our primary source of operating cash flows is collections from our customers and/or third party payers for radiology services we provide, and our primary uses of cash from operating activities include compensation paid to employees and independent contractor physicians and costs associated with our leased facilities. During the three months ended March 31, 2010 and 2009, net cash provided by operating activities was $3.2 million and $6.7 million, respectively.

     Cash flows from operating activities during the three months ended March 31, 2010 and 2009 consisted of net income of $1.9 million and $1.4 million, respectively, and adjustments for non-cash items of $2.1 million and $3.9 million, respectively. During the three months ended March 31, 2010, adjustments for non-cash items primarily included depreciation and amortization and changes in medical malpractice loss reserves and deferred income taxes. During the three months ended March 31, 2009, adjustments for non-cash items primarily included depreciation and amortization and changes in medical malpractice loss reserves. Other cash flows from operating activities resulted from changes in operating assets and liabilities, including cash outflows and cash inflows of approximately $770,000 and $1.4 million, respectively, during the three months ended March 31, 2010 and 2009.

     Cash Flows from Investing Activities

     Our uses of cash flows from investing activities consist primarily of capital expenditures related to equipment and software associated with the continued enhancement of our information technology infrastructure. Cash flows from investing activities during the three months ended March 31, 2010 and 2009 included capital expenditures of approximately $606,000 and $2.2 million, respectively. In addition, during the quarter ended March 31, 2010, we acquired certain assets of a radiology practice for total cash consideration of $400,000. During the three months ended March 31, 2010 and 2009, net cash used in investing activities was $1.0 million and $3.3 million, respectively.

     Cash Flows from Financing Activities

     Our primary sources of cash flows from financing activities are generally from excess tax benefits from stock option exercises and our primary uses of cash from financing activities are generally for the repurchases of our common stock. During the three months ended March 31, 2010 and 2009, net cash (used in) provided by financing activities was ($6,000) and $367,000, respectively.

     Future Liquidity Requirements

     We believe that our cash balances and the expected cash flow from our operations will be sufficient to fund our operating activities, working capital and capital expenditure requirements for the foreseeable future. We expect our long-term liquidity needs to consist primarily of working capital and capital expenditure requirements, as well as potential investments in, or acquisitions of, complementary businesses, services or technology. We intend to fund these long-term liquidity needs from cash generated from operations along with cash generated by potential future financing transactions. However, our ability to generate cash is subject to our performance,

21

general economic conditions, industry trends and other factors. Many of these factors are beyond our control and cannot be anticipated at this time. To the extent that existing cash and cash equivalents, and cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. Potential investments or acquisitions could also require us to seek additional debt or equity financing. Additional funds may not be available on terms favorable to us or at all. If additional funds are obtained by issuing equity securities, substantial dilution to existing stockholders may result.

Contractual Obligations and Commitments

     On December 7, 2007, we entered into an agreement to lease approximately 82,000 square feet of space in Eden Prairie, Minnesota, to consolidate our corporate headquarters. The lease commenced on March 2, 2009 and expires on August 31, 2019. In conjunction with the lease, we were entitled to a tenant improvement allowance of approximately $2.7 million, and upon commencement of the lease, we recorded the allowance in leasehold improvements and deferred tenant lease allowance. The amounts for leasehold improvements and deferred tenant lease allowance are included in Property and equipment, net and Deferred tenant lease allowance, respectively on the Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009. In addition, the lease arrangement contains a rent escalation clause and the related lease expenses are recognized on a straight-line basis over the term of the lease. Deferred rent associated with this lease in the amount of $859,000 and $852,000 is included in Other liabilities on the Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009, respectively.

     Excluded from contractual obligations and commitments are certain amounts related to our uncertain tax positions, as the timing and amount of any payment related to these tax positions remain uncertain. As of March 31, 2010, we have recognized $202,000 related to these uncertain tax positions.

Significant Accounting Policies and Estimates

     We describe our significant accounting policies in Note 1,Significant Accounting Policies and Estimates,of the Notes to the Consolidated Financial Statements included in this report.

     Principles of Consolidation

     We consolidate our financial results in accordance with accounting guidance on consolidations and variable interest entities, which requires a primary beneficiary to consolidate entities determined to be variable interest entities, or VIEs. We have determined that the Affiliated Medical Practices are VIEs, and that vRad is the primary beneficiary of the Affiliated Medical Practices.

     The following tables show the unaudited condensed consolidating balance sheets as of March 31, 2010 and December 31, 2009, and the unaudited condensed consolidating statements of operations for the three months ended March 31, 2010 and 2009. The amounts reflected in the eliminations columns of the condensed consolidating financial statements represent affiliated party management and professional services fees. The following tables should be read together with our consolidated financial statements and related notes included elsewhere in this report.

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Condensed Consolidating Balance Sheets
(unaudited)

	As of March 31, 2010
			Affiliated
			Medical
	vRad		Practices			Eliminations			Consolidated
	(in thousands)
Cash and cash equivalents	$	51,910	$	482		$	—		$	52,392
Accounts receivable, net		10,862		7,589			—			18,451
Other current assets		40,589		51,889			(88,094	)		4,384
Non-current assets		21,699		15			—			21,714
Total assets	$	125,060	$	59,975		$	(88,094	)	$	96,941
Current liabilities	$	35,165	$	66,830		$	(88,094	)	$	13,901
Non-current liabilities		11,261		—			—			11,261
Total liabilities		46,426		66,830			(88,094	)		25,162
Stockholders’ equity (deficiency)		78,634		(6,855	)		—			71,779
Total liabilities and stockholders’ equity	$	125,060	$	59,975		$	(88,094	)	$	96,941

	As of December 31, 2009
			Affiliated
			Medical
	vRad		Practices			Eliminations			Consolidated
	(in thousands)
Cash and cash equivalents	$	49,159	$	1,004		$	—		$	50,163
Accounts receivable, net		9,706		7,678			—			17,384
Other current assets		34,701		38,629			(68,811	)		4,519
Non-current assets		21,898		20			478			22,396
Total assets	$	115,464	$	47,331		$	(68,333	)	$	94,462
Current liabilities	$	29,673	$	54,212		$	(68,811	)	$	15,074
Non-current liabilities		9,576		—			478			10,054
Total liabilities		39,249		54,212			(68,333	)		25,128
Stockholders’ equity (deficiency)		76,215		(6,881	)		—			69,334
Total liabilities and stockholders’ equity	$	115,464	$	47,331		$	(68,333	)	$	94,462

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Condensed Consolidating Statements of Operations
(unaudited)

	Three Months Ended March 31, 2010
			Affiliated
			Medical
	vRad		Practices			Eliminations			Consolidated
	(in thousands)
Revenue	$	24,309	$	26,401		$	(19,897	)	$	30,813
Operating costs and expenses		21,124		26,410			(19,897	)		27,637
Operating income (loss)		3,185		(9	)		—			3,176
Other income		44		—			—			44
Income (loss) before income tax expense		3,229		(9	)		—			3,220
Income tax expense (benefit)		1,302		(36	)		—			1,266
Net income	$	1,927	$	27		$	—		$	1,954

	Three Months Ended March 31, 2009
			Affiliated
			Medical
	vRad		Practices		Eliminations			Consolidated
	(in thousands)
Revenue	$	21,863	$	26,020	$	(19,315	)	$	28,568
Operating costs and expenses		19,965		25,632		(19,315	)		26,282
Operating income		1,898		388		—			2,286
Other income		56		—		—			56
Income before income tax expense		1,954		388		—			2,342
Income tax expense		782		168		—			950
Net income	$	1,172	$	220	$	—		$	1,392

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ITEM 3. Quantitative and Qualitative Disclosure About Market Risk

Foreign Currency Exchange Risk

     As of March 31, 2010, we did not have significant exposure to foreign currency exchange rates, as substantially all of our transactions are denominated in U.S. dollars. VRL’s functional currency is the British pound; however, as of and for the three months ended March 31, 2010, VRL’s operations were not significant and did not have a material impact on our consolidated financial position, results of operations or cash flows.

Interest Rate Market Risk

     Our cash is invested in commercial paper and demand deposit accounts denominated in U.S. dollars. The carrying value of our cash, restricted cash, accounts receivable, other current assets, trade accounts payable, accrued expenses and customer security deposits approximate fair value because of the short period of time to their maturity.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     As of the end of the period covered by this report, or the Evaluation Date, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, or the Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

     During the period covered by this report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — Other Information

ITEM 1. Legal Proceedings

     We are from time to time subject to, and are presently involved in, litigation and legal proceedings arising out of the ordinary course of business, including medical malpractice claims and certain employment related matters. We believe that neither we, nor, to our knowledge, any of our independent contractor physicians, are presently a party to any litigation, the outcome of which could have a material adverse effect on us.

     We maintain professional and general liability insurance policies with third-party insurers on a claims-made basis, subject to deductibles, self-insured retention limits, policy aggregates, exclusions, and other restrictions, in accordance with standard industry practice. Our self-insured retention under our professional liability insurance program is insured through VPIL, our wholly-owned captive insurance subsidiary. We believe that our insurance coverage is appropriate based upon our claims experience and the nature and risks of our business. However, we cannot assure that any pending or future claim will not be successful or if successful will not exceed the limits of available insurance.

ITEM 6. Exhibits

     Exhibits are incorporated herein by reference or are filed with this quarterly report as set forth below:

EXHIBIT INDEX

Exhibit No.	Description
31.1	Certification by Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.***
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.***
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***

*** Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Leonard C. PurkisLeonard C. Purkis	Chief Financial Officer (Principal Financial and Accounting Officer, and Duly Authorized Officer)	April 28, 2010

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