U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
[ ] 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 0-21427
INTEGRATED MEDICAL RESOURCES, INC.
(Exact name of Small Business Issuer as specified in its charter)
Kansas 48-1096410
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
11320 West 79th Street, Lenexa, KS 66214
(Address of principal executive offices) (Zip code)
Issuer's Telephone Number: (913) 962-7201
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 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
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
As of October 31, 1998, there were 10,438,029 outstanding shares of common
stock, par value $.001 per share.
Transitional Small Business Disclosure Format (Check one): Yes No X
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
======================================================================================================================
September 30, December 31,
ASSETS 1998 1997
(unaudited)
------------------------ --------------------------
CURRENT ASSETS:
Cash and cash equivalents $ 265,279 $ 765,204
Accounts receivable, less allowance of $3,845,669 in 1998 and
$2,074,660 in 1997 5,458,812 8,411,413
Supplies 356,024 407,071
Prepaid expenses 185,945 101,640
------------------------ --------------------------
Total current assets 6,266,060 9,685,328
NON-CURRENT ASSETS:
Property and equipment:
Furniture, fixtures and equipment 8,775,617 8,351,703
Leasehold improvements 176,988 151,836
------------------------ --------------------------
8,952,605 8,503,539
Accumulated depreciation 4,127,250 2,801,377
------------------------ --------------------------
4,825,355 5,702,162
Goodwill 842,675 ---
Intangible assets 293,657 182,843
Other assets 301,595 239,439
------------------------ --------------------------
TOTAL ASSETS $ 12,529,342 $ 15,809,772
------------------------ --------------------------
See accompanying notes to financial statements
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1
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INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (continued)
======================================================================================================================
September 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
(unaudited)
--------------------- --------------------------
CURRENT LIABILITIES:
Accounts payable $ 4,360,011 $ 3,793,008
Accrued payroll 838,989 647,582
Accrued advertising 425,943 773,468
Accrued restructuring charge 407,112 628,120
Other accrued expenses 137,147 188,980
Working capital line of credit 1,279,333 3,085,954
Current portion of long-term debt 2,593,433 2,685,491
Current portion of capital lease obligations 176,997 245,684
--------------------- --------------------
Total current liabilities 10,218,965 12,048,287
NON-CURRENT LIABILITIES:
Deferred rent 216,426 195,748
Long-term debt, less current portion 759,900 1,325,282
Capital lease obligations, less current portion 52,015 139,898
--------------------- --------------------
Total non-current liabilities 1,028,341 1,660,928
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value:
Authorized shares - 1,696,698
Issued and outstanding shares - 2,000 2 ---
Common stock, $.001 par value:
Authorized shares - 25,000,000
Issued and outstanding shares - 10,438,029 10,437 6,731
Treasury stock, at cost (11,347) (11,347)
Additional paid-in capital 27,701,955 18,219,781
Accumulated deficit (26,419,011) (16,114,608)
--------------------- --------------------
Total stockholders' equity 1,282,036 2,100,557
--------------------- --------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,529,342 $ 15,809,772
--------------------- --------------------
See accompanying notes to financial statements
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2
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INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
- - -----------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------
For the three months For the nine months
ended ended
September 30 September 30
--------------------------------------------------------------
--------------------------------------------------------------
1998 1997 1998 1997
--------------------------------------------------------------
NET REVENUE: $2,140,175 6,230,921 $10,961,801 $15,352,920
Center operating expenses:
Physician salaries 680,555 909,859 2,411,402 2,736,186
Cost of services 662,267 1,439,517 2,359,225 3,348,387
Center staff salaries 481,695 641,460 1,505,879 1,749,569
Center facilities rent 249,962 341,922 840,306 1,015,287
Bad debt expense 1,899,323 131,284 2,980,546 325,622
--------------------------------------------------------------
Total center operating expenses 3,973,802 3,464,042 10,097,358 9,175,051
--------------------------------------------------------------
Center contribution (1,833,627) 2,766,879 864,443 6,177,869
--------------------------------------------------------------
CORPORATE EXPENSES:
Advertising 1,082,379 1,432,182 3,470,071 4,138,388
Selling, general and administrative 1,877,103 1,597,121 5,410,658 4,316,807
Depreciation and amortization 470,926 514,790 1,403,313 1,617,815
Restructuring charge --- --- 243,423 ---
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Total corporate expenses 3,430,408 3,544,093 10,527,465 10,073,010
--------------------------------------------------------------
Operating loss (5,264,035) (777,214) (9,663,022) (3,895,141)
--------------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest income 857 14,754 4,032 115,487
Interest expense (165,226) (106,410) (643,961) (285,039)
Other (1,452) (19,258) (1,452) (10,905)
--------------------------------------------------------------
(165,821) (110,914) (641,381) (180,457)
--------------------------------------------------------------
NET LOSS $ (5,429,856) $ (888,128) $ (10,304,403) $ (4,075,598)
--------------------------------------------------------------
Net loss per common share -- basic and diluted $ (.54) $ (.13) $ (1.21) $ (.61)
--------------------------------------------------------------
Basic and diluted weighted average common
shares outstanding 10,125,312 6,717,517 8,484,147 6,717,517
--------------------------------------------------------------
See accompanying notes to financial statements
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3
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INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
======================================================================================================================
For the nine months ended
September 30
===================================================
1998 1997
-------------------------- ------------------------
OPERATING ACTIVITIES:
Net loss $ (10,304,403) $ (4,075,598)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 1,242,585 924,098
Amortization 160,728 693,717
Provision for bad debts 1,714,009 346,357
Deferred rent 20,678 ---
Pre-opening costs incurred --- (116,090)
Changes in operating assets and liabilities:
Accounts receivable 1,439,931 (3,231,343)
Supplies 51,047 (92,043)
Prepaid expenses (82,819) 18,388
Accounts payable 542,025 (1,662,153)
Accrued payroll 191,407 18,961
Accrued advertising 347,525) 1,673
Other accrued expenses 283,941) 296,198
-------------------------- ------------------------
Net cash used in operating activities (5,656,278) (6,877,835)
-------------------------- ------------------------
INVESTING ACTIVITIES:
Acquisition of Arizona Advanced Vascular, LTD (250,000) ---
Purchases of property and equipment (48,499) (584,614)
Other (138,996) (301,625)
-------------------------- ------------------------
Net cash used in investing activities (437,495) (886,239)
-------------------------- ------------------------
FINANCING ACTIVITIES:
Principal payments on line of credit (1,806,621) ---
Borrowings on line of credit --- 1,983,304
Proceeds from issuance of notes payable and long-term debt --- 490,000
Proceeds from issuance of convertible debt 1,200,000 ---
Principal payments on long-term debt (938,152) (580,633)
Debt issuance costs incurred (35,936) ---
Net principal payments on capital lease obligations (220,246) (98,782)
Purchase of common stock --- (11,347)
Proceeds from issuance of common stock 5,601,974 2
Proceeds from issuance of preferred stock 1,792,829 ---
-------------------------- ------------------------
Net cash provided by financing activities 5,593,848 1,782,544
-------------------------- ------------------------
Net decrease in cash and cash equivalents (499,925) (5,981,530)
Cash and cash equivalents at beginning of period 765,204 6,739,697
-------------------------- ------------------------
Cash and cash equivalents at end of period $ 265,279 $ 758,167
-------------------------- ------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid for interest $ 399,790 $ 202,108
SUPPLEMENTAL SCHEDULE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Additions to property and equipment through issuance of long
term debt --- $ 492,000
Acquisition of Wellteck Medical Network, Inc. through
issuance of common stock $ 822,000 ---
Conversion of long-term debt to common stock 1,273,846 ---
---------------------------------------------------
See accompanying notes to financial statements
4
INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Integrated Medical Resources, Inc. and subsidiaries (the "Company") is
a provider of management services to clinics providing disease management
services for men suffering from sexual dysfunction. At September 30, 1998, the
Company managed 25 diagnostic clinics operated under the name The Diagnostic
Center for Men in 17 states (collectively the "Centers"). Each of those 25
clinics has entered into long-term management contracts and lease agreements
with the Company. Pursuant to these contracts and agreements, the Company
provides a wide array of business services to the Centers in exchange for
management fees. The Company also manages one blood testing lab formerly managed
by Wellteck Medical Network, Inc.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared by the Company, in accordance with generally accepted accounting
principles for interim financial information, and with the instructions to Form
10-QSB. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's December 31,
1997 annual report on Form 10-KSB. The results of operations for the three and
nine month periods ended September 30, 1998 are not necessarily indicative of
the operating results that may be expected for the year ended December 31, 1998.
NOTE 2 - CONTINGENCIES
The Company is subject to extensive federal and state laws and
regulations, many of which have not been the subject of judicial or regulatory
interpretation. Management believes the Company's operations are in substantial
compliance with laws and regulations. Although an adverse review or
determination by any such authority could be significant to the Company,
management believes the effects of any such review or determination would not be
material to the Company's financial condition. See "Factors That May Affect
Future Results of Operations - Medicare Reimbursement."
NOTE 3 - SUBSEQUENT EVENTS
On October 6, 1998, the Company obtained bridge loans totaling $700,000
provided by previous investors, including some affiliated with Directors of the
Company.
On October 15, 1998, the Company was notified by The Nasdaq Stock
Market that delisting from the Nasdaq National Market was being considered due
to a lack of compliance with the listing
5
requirements. An oral hearing has been requested by the Company in order to
preserve its listing on the Nasdaq National Market.
On November 12, 1998, the Company announced that it has filed for
protection under Chapter 11 of the U.S. Bankruptcy Code. It was also announced
that the Company instituted immediate and significant reductions in the Lenexa,
Kansas headquarters staff and temporarily closed many clinic locations. In
addition, the planned merger with Century Medical Group was canceled. This
followed an announcement on November 5, 1998 that the Company did not meet
payroll for the last two weeks of October.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company's managed Centers are the leading provider of disease
management services for men suffering from sexual dysfunction, focusing
primarily on the diagnosis and treatment of erectile dysfunction, commonly known
as impotence. The Centers provide comprehensive diagnostic, educational and
treatment services designed to address the medical and emotional needs of their
patients and their partners through the largest network of medical clinics in
the United States dedicated to the diagnosis and treatment of impotence. As of
September 30, 1998, the Company manages 25 Centers in 17 states and one blood
testing lab.
For the three and nine months ended September 30, 1998, approximately
79% and 81%, respectively, of patient billings were covered by medical insurance
plans subject to applicable deductible and other co-pay provisions paid by the
patient. Approximately 23% and 27%, respectively, of patient billings were
covered by Medicare and 57% and 54%, respectively, were covered by numerous
other commercial insurance plans that offer coverage for impotence treatment
services. Patient billings average less for Medicare patients due to
restrictions on laboratory test reimbursement and standard professional fee
discounts.
6
Results of Operations
The following table sets forth, for the periods indicated, certain
items from the consolidated statements of operations of the Company as a
percentage of net revenue:
====================================================================================================
For the three months For the nine months
ended September 30 ended September 30
---------------------------------------------------------
---------------------------------------------------------
1998 1997 1998 1997
---------------------------------------------------------
Net revenue 100.0% 100.0% 100.0% 100.0%
Center operating expenses:
Physician salaries 31.8 14.6 22.0 17.8
Cost of services 30.9 23.1 21.5 21.8
Center staff salaries 22.5 10.3 13.7 11.4
Center facilities rent 11.7 5.5 7.7 6.7
Bad debt expense 88.8 2.1 27.2 2.1
--------------------------------------------------------
Total center operating expenses 185.7 55.6 92.1 59.8
--------------------------------------------------------
Center contribution (85.7) 44.4 7.9 40.2
Corporate expenses:
Advertising 50.6 23.0 31.7 27.0
Selling, general and administrative 87.7 25.6 49.4 28.1
Depreciation and amortization 22.0 8.3 12.8 10.5
Restructuring charge 0.0 0.0 2.2 0.0
--------------------------------------------------------
Total corporate expenses 160.3 56.9 96.1 65.6
--------------------------------------------------------
Operating loss (246.0) (12.5) (88.2) (25.4)
Interest expense, net (7.7) (1.8) (5.8) (1.1)
--------------------------------------------------------
Net loss (253.7) (14.3) (94.0) (26.5)
===================================================================================================
Three Months Ended September 30, 1998 and 1997
Net Revenue. Net revenue decreased approximately 66% from $6,230,921 in
1997 to $2,140,175 in the same period of 1998. This was primarily due to a 41%
decline in the number of new patients seen during the quarter compared with the
same quarter in 1997, resulting from a smaller number of clinics in operation
and a curtailed advertising spend caused by the Company's severe cash
constraints. In addition, the Company experienced a 32% decrease in diagnostic
revenue per new patient versus the third quarter of 1997. The diagnostic revenue
per new patient was unchanged from the second quarter of 1998. As previously
reported, the release of Viagra(R) caused what the Company believes to be a
transient influx of new patients seeking Viagra(R) but not wishing to pursue a
diagnosis for their symptom of impotence.
Physician Salaries. Physician salaries decreased approximately 25% from
$909,859 in 1997 to $680,555 in 1998 due to the closing of five clinics in
December 1997 and the closing of five additional clinics in June 1998. Due to
the decreased net revenue for the third quarter 1998, physician salaries
increased as a percentage of net revenue from 14.6% in 1997 to 31.8% in 1998.
Cost of Services. Cost of services represent direct operating expenses
of the Centers, including costs for laboratory and outsourced services,
diagnostic and treatment supplies and treatment devices,
7
decreased approximately 54% from $1,439,517 in 1997 to $662,267 in 1998 due to
the decline in number of patients seen and the decrease in the number of clinics
under management from the previous year. As a percentage of net revenue, cost of
services increased from 23.1% to 30.9%.
Center Staff Salaries. Center staff salaries decreased approximately
25% from $641,460 in 1997 to $481,695 in 1998 due primarily to the closing of
five clinics in December 1997 and the closing of five additional clinics in June
1998. As a percentage of net revenue, center staff salaries increased from 10.3%
to 22.5%, due to decreased revenues during the third quarter of 1998.
Center Facilities Rent. Center facilities rent decreased approximately
27% from $341,922 in 1997 to $249,962 in 1998 due to the closing of five clinics
in December 1997 and the closing of five additional clinics in June 1998. As a
percentage of net revenue, center facilities rent increased from 5.5% to 11.7%,
due to decreased revenues in the Centers.
Bad Debt Expense. Bad debt expense increased by $1,768,040 from
$131,284 to $1,899,324. In 1998 the Company implemented a plan to improve the
collection rate of the accounts receivable by following up via telephone calls
with the Medicare and private insurance carriers. In doing so, the Company
discovered various reasons why accounts had not been collected. Those reasons
included claims which required additional information, claims waiting for the
processing of provider numbers to be issued, claims which were not filed timely
due to processing time of provider numbers, and claims for services which were
denied by Medicare and the insurance carrier. Based on the results of this
follow up, the Company determined that certain claims were uncollectable and
were written off. The Company has implemented a policy to more closely monitor
the allowance for doubtful accounts to more accurately reflect its actual bad
debt experience.
Center Contribution. Center contribution decreased approximately 166%
from $2,766,879 in 1997 to a loss of $1,833,627 in 1998 due primarily to the
decrease in net revenue and secondarily to a large write-off of prior year
accounts receivables to bad debt expense. The center operating expenses,
excluding bad debts, decreased by approximately 38%, however, this decrease of
$1,258,280 was offset by the increase in the bad debt expense of $1,768,000.
Advertising. Advertising expense decreased approximately 24% from
$1,432,182 in 1997 to $1,082,379 in 1998 due to the suspension of broadcast
(television and radio) advertisements in late August. These broadcast
advertisements were curtailed due to the Company's severe cash constraints. See
"Liquidity and Capital Resources." As a percentage of net revenue, advertising
expense increased from 23.0% in 1997 to 50.6% in 1998, due to decreased revenues
during the third quarter of 1998.
Depreciation and Amortization. Depreciation and amortization decreased
approximately 9% from $514,790 in 1997 to $470,926 in 1998 due to the completion
of amortization of the pre-opening costs incurred with respect to the
significant growth in new centers in 1996. As a percentage of net revenue,
depreciation and amortization increased from 8.3% to 22.0%.
Selling, General and Administrative. Selling, general and
administrative expense increased approximately 18% from $1,597,121 in 1997 to
$1,877,103 in 1998 due to legal, accounting, and consulting costs related to the
pursuance of additional financing and clinic mergers and acquisitions. As a
percentage of net revenue, selling, general and administrative expense increased
from 25.6% to 87.7%.
Interest Expense, Net. Interest expense increased from $110,914 in 1997
to $165,821 in 1998, as the Company utilized its working capital line of credit
to fund cash flow deficits resulting from operating losses. Additionally, the
Company recognized interest expense resulting from the $1.2 million convertible
subordinated promissory notes and attached warrants issued in July 1998 (the
Stockholder Loan).
8
Income Taxes. No income tax provision or benefit was recorded in 1997 or
1998 as the deferred taxes otherwise provided were offset by valuation reserves
on deferred tax assets.
9
Nine Months Ended September 30, 1998 and 1997
Net Revenue. Net revenue decreased approximately 29% from $15,352,920
in 1997 to $10,961,801 in 1998 due to the decline in net revenues during the
second and third quarters of 1998 as previously described. In addition, the
Company recorded additional contractual adjustments as a result of the follow up
work performed during the first nine months of 1998, as discussed above under
Bad Debt Expense. The Company is continuing to refine its estimation of
contractual adjustments to more accurately reflect its actual experience.
Physician Salaries. Physician salaries decreased approximately 12% from
$2,736,186 in 1997 to $2,411,402 in 1998 due to the closing of five clinics in
December 1997 and the closing of five additional clinics in June 1998. As a
percentage of net revenue, physician salaries increased from 17.8% to 22.0% due
to decreased net revenue during the second and third quarters of 1998.
Cost of Services. Cost of services expenses decreased approximately 30%
from $3,348,387 in 1997 to $2,359,225 in 1998 due to the closing of five clinics
in the fourth quarter 1997 and the closing of five additional clinics in June
1998. As a percentage of net revenue, cost of services decreased from 21.8% to
21.5%, primarily as a result of the elimination of the greater expenses compared
to revenues of the seven clinics closed in the fourth quarter 1997 and five
additional clinics closed in June 1998.
Center Staff Salaries. Center staff salaries decreased approximately
14% from $1,749,569 in 1997 to $1,505,879 in 1998 due primarily to the closing
of five clinics in December 1997 and the closing of five additional clinics in
June 1998. As a percentage of net revenue, center staff salaries increased from
11.4% to 13.7% due to decreased net revenue during the second and third quarters
of 1998.
Center Facilities Rent. Center facilities rent decreased approximately
17% from $1,015,287 in 1997 to $840,306 in 1998 due primarily to the closing of
five clinics in December 1997 and the closing of five additional clinics in June
1998. As a percentage of net revenue, center facilities rent increased from 6.7%
to 7.7% due to the decreased net revenue in the second and third quarters of
1998.
Bad Debt Expense. For the reasons described above, bad debt expense
increased by $2,654,925 from $325,622 to $2,980,547.
Center Contribution. Center contribution decreased by 86% from
$6,177,869 to $864,443. The net revenue decreased by 29% or $4,391,000. The
clinic operating expenses, excluding bad debts, decreased by approximately 20%,
however, this decrease of $1,733,000 was offset by the increase in the bad debt
expense of $2,655,000.
Advertising. Advertising expense decreased approximately 16% from
$4,138,388 in 1997 to $3,470,071 in 1998 due to the curtailment of broadcast
advertisements in the third quarter of 1998 as previously described and the
transition of media buying agencies. This transition decreased agency management
fees significantly, and by adopting their tracking systems, provided the Company
media efficiencies. As a percentage of net revenue, advertising expense
increased from 27.0% to 31.7% due to decreased net revenue during the second and
third quarters of 1998.
Depreciation and Amortization. Depreciation and amortization decreased
approximately 13% from $1,617,815 in 1997 to $1,403,313 in 1998 due to
completion of amortization of pre-opening costs incurred with respect to the
eighteen new Centers opened from January 1996 to January 1997. As a percentage
of net revenue, depreciation and amortization increased from10.5% to 12.8%, due
to decreased net revenue during the second and third quarters of 1998.
Pre-opening costs are amortized over a 12-month period.
10
Selling, General and Administrative. Selling, general and
administrative expense increased approximately 25% from $4,316,807 in 1997 to
$5,410,658 in 1998 due principally to legal, accounting and consulting costs
related to the pursuance of additional financing issuances and clinic mergers
and acquisitions, expansion of the telephone appointment center staff in late
1997 to support higher call volumes in response to more effective advertising,
additional staffing in accounting and additional staffing in billing and
collections in order to improve the accuracy of billing and collection of
outstanding accounts receivable. As a percentage of net revenue, selling,
general and administrative expense increased from 28.1% to 49.4%, both as a
result of the above described expenses and decreased net revenue.
Interest Expense, Net. For the reasons described above, interest
expense increased from $180,457 in 1997 to $641,381 in
1998.
Income Taxes. No income tax provision or benefit was recorded in 1997
or 1998 as the deferred taxes otherwise provided were offset by
valuation reserves on deferred tax assets.
11
Liquidity and Capital Resources
Through 1997 and the first nine months of 1998, the Company experienced
significant cash flow shortages as expenses exceeded cash receipts and accounts
receivable collections were slowed or, due to certain Medicare reimbursement
issues, suspended. As a result of these shortages, the Company obtained the line
of credit in 1997 and equity infusions of $5.6 million in the first six months
of 1998. In addition, the Company issued preferred stock of $2.0 million and
received proceeds from the issuance of convertible debt of $1.2 million in the
second and third quarter of 1998. During the third quarter of 1998, the
Company's cash flow shortages became more severe due to contraction of the
borrowing base under the line of credit. As the Company's accounts receivable
have fallen due to lower net revenues and increased collections, greater
repayments have been required under the line of credit.
Due to the growth in the number of new center openings and fluctuations
in patient flows, the Company has experienced increased and varied operating
cash flow deficits from its inception. This resulted primarily from differences
in working capital levels (particularly, accounts receivable) required to
accommodate the increased services to centers and variances in operating
results. The variances were principally attributable to the fact that revenues
at new centers have generally increased with patient volumes over the first six
months of operations while operating expenses have remained relatively fixed
from the first month of operation. In addition, the Company had increased
corporate staff, expanded the national call center and increased advertising
costs to support new center openings, thereby significantly increasing
administrative expenses in advance of expected revenues. As a result of patients
seeking Viagra(R) and not seeking diagnostic testing for their symptom of
impotence, revenues for the second quarter decreased due to lower new patient
revenue. Less advertising dollars spent in the third quarter also resulted in
lower net patient revenue. The Company has taken measures intended to reduce
operating losses and improve cash flow through the closing of seven centers in
the fourth quarter 1997, five centers in June 1998, cancellation of the planned
opening of an additional center and reductions in corporate staffing in January
and June 1998. The Company was also in the process of acquiring other men's
health clinic management businesses in order to increase revenues and achieve
operating and advertising cost synergies.
The Company has financed its operations and met its capital
requirements with cash flows from services provided to existing Centers,
proceeds from private placements of equity securities, an initial public
offering of equity securities, the utilization of bank lines of credit, bank
loans and capital lease obligations. The Company has a working capital line of
credit with a finance company under which it may borrow up to $5.0 million
through October 24, 1999, based on specified percentages of eligible accounts
receivable. At September 30, 1998, the Company had $1,279,333 outstanding under
this Line of Credit, the maximum available based on eligible accounts receivable
balances. The interest rate applicable to the line of credit is 2.5% above the
Bank of America prime lending rate (which prime lending rate was 8.5% at
September 30, 1998). In October 1997, the Company entered into a $500,000 term
loan agreement with the finance company which provides the line of credit,
secured by property and equipment, payable in monthly installments through
October 2000, bearing interest at 12.74%.
In July 1998, the Company issued $800,000 in convertible subordinated
promissory notes to two major institutional shareholders (the "Stockholder
Loan"). Three of the Company's directors are affiliated with these institutional
shareholders. The notes are convertible into the securities issued in the
Company's next equity financing involving the receipt by the Company of, in the
aggregate, more than $4,000,000 at the purchase price paid by the investors in
that financing. Attached to these notes are warrants to purchase the Company's
common stock based upon a stated formula.
In July and August 1998, the Company issued $400,000 in a convertible
subordinated promissory note to E. Stanley Kardatzke, Trustee of the E. Stanley
Kardatzke Revocable Trust. The convertible subordinated promissory note is
convertible into the securities issued in the Company's next
12
equity financing involving the receipt by the Company of, in the aggregate, more
than $4,000,000 at the purchase price paid by the investors at that financing.
Attached to this note are warrants to purchase the Company's common stock based
upon a stated formula.
At September 30, 1998, the Company had cash and cash equivalents of
$265,000. Accounts receivable, net of allowance, decreased $2,952,601, from
$8,411,413 at December 31, 1997 to $5,458,812 at September 30, 1998. The
decrease in accounts receivable is primarily due to decreases in net revenue and
bad debt write-offs. The September 30, 1998 amount includes $175,000 recently
submitted for Medicare reimbursement after completion of appropriate provider
registration requirements or pending submission awaiting completion of those
requirements. In addition, $656,162 in Medicare billings were under payment
suspension, see "Factors That May Affect Future Results of Operations - Medicare
Reimbursement."
The Company is continuing to seek additional working capital financing
through equity and debt sources although there can be no assurance that any such
funds can be obtained. Without additional working capital, the Company may not
be able to satisfy its working capital requirements through the end of the year.
Year 2000 Compliance
Many computer software and hardware systems currently are not, or will
or may not be, able to read, calculate or output correctly using dates after
1999, and such systems will require significant modifications in order to be
"year 2000 compliant." This issue may adversely affect the operations and
financial performance of the Company because its computer systems are an
integral part of the Company's health care delivery activities as well as its
accounting and other information systems and because the Company will have to
divert financial resources and personnel to address this issue.
The Company has begun to review its computer hardware and software
systems. The existing systems will be upgraded either through modifications, or
replacement. The Company currently anticipates this upgrading to be completed by
July 1, 1999.
Although the Company is not aware of any material operational
impediments associated with upgrading its computer hardware and software systems
to be year 2000 compliant, the Company cannot make any assurances that the
upgrade of the Company's computer systems will be completed on schedule or that
the upgraded systems will be free of defects. If any such risks materialize, the
Company could experience material adverse consequences, material costs or both.
Year 2000 compliance may also adversely affect the operations and
financial performance of the Company indirectly by causing complications of, or
otherwise affecting, the operations of any one or more of the Company's vendors.
The Company intends to contact its significant vendors in the last half of
calendar year 1998 in an attempt to identify any potential year 2000 compliance
issues with them. The Company is currently unable to anticipate the magnitude of
the operational or financial impact on the Company of year 2000 compliance
issues with its vendors.
The Company expects to incur approximately $100,000 in each fiscal
quarter beginning with the fourth quarter of 1998 through the third quarter of
1999 to resolve the Company's year 2000 compliance issues. All expenses incurred
in connection with year 2000 compliance will be expensed as incurred, other than
acquisitions of new software or hardware, which will be capitalized.
13
Factors That May Affect Future Results of Operations
Ability to Manage Growth. Through 1997, the Company experienced rapid
growth that resulted in new and increased responsibilities for management
personnel and has placed increased demands on the Company's management,
operational and financial systems and resources. To accommodate this growth and
to compete effectively and manage future growth, the Company will be required to
continue to implement and improve its operational, financial and management
information systems, and to train, motivate and manage its work force. There can
be no assurance that the Company's personnel, systems, procedures and controls
will be adequate to support the Company's operations. Any failure to implement
and improve the Company's operational, financial and management systems or to
train, motivate or manage employees could have a material adverse effect on the
Company's financial condition and results of operations.
The Company intends to establish clinics in new markets where it has
never before provided services. As part of its market selection analysis, the
Company has invested and will continue to invest substantial funds in the
compilation and examination of market data. There can be no assurance that the
market data will be accurate or complete or that the Company will select markets
in which it will achieve profitability.
In addition, the Company has recently committed to and will continue to
pursue acquisitions of medical clinics or practices providing male sexual health
services. There are various risks associated with the Company's acquisition
strategy, including the risk that the Company will be unable to identify,
recruit or acquire suitable acquisition candidates, or to integrate and manage
the acquired clinics or practices, or to fund the operations of acquired
clinics. There can be no assurance that clinics and practices will be available
for acquisition by the Company on acceptable terms, or that any liabilities
assumed in an acquisition will not have a material adverse effect on the
Company's financial condition and results of operations.
Seasonality and Fluctuations in Quarterly Results. The Company's
historical quarterly revenues and financial results prior to 1997 demonstrated a
seasonal pattern in which the first and fourth quarters were typically stronger
than the second and third quarters. The summer months of May through August have
showed seasonal decreases in patient volume and billings. In 1997 and in 1998 to
date, this seasonal downturn was not indicated in patient volumes although there
was a decrease in call volumes. The Company cannot predict that this seasonality
will not be demonstrated in the future and there can be no assurance that such
seasonal fluctuations will not produce decreased revenues and poorer financial
results. The failure to open new Centers on anticipated schedules, the opening
of multiple Centers in the same quarter or the timing of acquisitions may also
have the effect of increasing the volatility of quarterly results. Any of these
factors could have a material adverse impact on the Company's stock price.
Dependence on Reimbursement bv Third Party Payors. For the quarter
ended September 30, 1998, approximately 79% of patient billings were covered by
medical insurance plans subject to applicable deductibles and other co-pay
provisions paid by the patient. Approximately 23% of patient billings were
covered by Medicare and 57% were covered by numerous other commercial insurance
plans that offer coverage for impotence treatment services. The health care
industry is undergoing cost containment pressures as both government and
non-government third party payors seek to impose lower reimbursement and
utilization rates and to negotiate reduced payment schedules with providers.
This trend may result in a reduction from historical levels of per-patient
revenue for such health care providers. Further reductions in third party
payments to physicians or other changes in reimbursement for health care
services could have a direct or indirect material adverse effect on the
Company's financial condition and results of operations. In addition, as managed
Medicare arrangements continue to become more prevalent, there can be no
assurance that the Centers will qualify as a provider for relevant
14
arrangements, or that participation in such arrangements would be profitable.
Any loss of business due to the increased penetration of managed Medicare
arrangements could have a material adverse effect on the Company's financial
condition and results of operations.
The Company has recently been informed by certain Medicare carriers
that under their interpretation of Medicare policies, these carriers intend to
limit the circumstances for coverage of certain diagnostic testing for
impotence. Although the Company intends to appeal these carriers'
interpretation, if it is determined that the Company will no longer be
reimbursed for these services, the loss of revenue could have a material adverse
effect on the Company's financial condition and results of operations.
The Company's net income is affected by changes in sources of the
Centers' revenues. Rates paid by commercial insurers, including those which
provide Medicare supplemental insurance, are generally based on established
provider charges, and are generally higher than Medicare reimbursement rates. A
change in the payor mix of the Company's patients resulting in a decrease in
patients covered by commercial insurance could adversely affect the Company's
financial condition and results of operations.
Health Care Industry and Regulation. The health care industry is highly
regulated at both the state and federal levels. The Company and the Centers are
subject to a number of laws governing issues as diverse as relationships between
health care providers and their referral sources, prohibitions against a
provider referring patients to an entity with which the provider has a financial
relationship, licensure and other regulatory approvals, professional advertising
restrictions, corporate practice of medicine, Medicare billing regulations,
dispensing of pharmaceuticals and regulation of unprofessional conduct of
providers, including fee-splitting arrangements. Many facets of the contractual
and operational structure of the Company's relationships with each of the
Centers have not been the subject of judicial or regulatory interpretation. An
adverse review or determination by any one of such authorities, or changes in
the regulatory requirements, or otherwise, could have a material adverse effect
on the operations, financial condition and results of operations of the Company.
In addition, expansion of the operations of the Company into certain
jurisdictions may require modifications to the Company's relationships with the
Centers located there. These modifications could include changes in such states
in the way in which the Company's services and lease fees are determined and the
way in which the ownership and control of the Centers are structured. Such
modifications may have a material adverse effect on the Company's financial
condition and results of operations.
In recent years, numerous legislative proposals have been introduced or
proposed in the United States Congress and in some state legislatures that would
effect major changes in the United States health care system at both the
national and state level. It is not clear at this time which proposals, if any,
will be adopted or, if adopted, what effect such proposals would have on the
Company's business. There can be no assurance that currently proposed or future
health care legislation or other changes in the administration or interpretation
of governmental health care programs will not have a material adverse effect on
the Company's financial condition and results of operations.
Furthermore, there can be no assurance that the method of payment for
the products and services furnished by the Centers will not be radically altered
in the future by changes in the health care industry. Changes in the system of
reimbursement, including Medicare, for the products and services provided by the
Centers that increase the difficulty of obtaining payment for medical services
could have a material adverse effect on the Company's financial condition and
results of operations, as the Company's income stream depends upon revenues of
the Centers. If revenues of the Centers are diminished, either in quantity or in
continuity, the Company will be adversely affected.
15
Medicare Reimbursement. Historically, the percent of DCM patients for
which reimbursement is sought from Medicare has averaged approximately 30%
system-wide, although such average ranges from approximately 15% to 53% among
individual Centers. Medicare reimbursements for professional services are
processed by numerous carriers ("Service Carriers") and reimbursements for
durable medical equipment ("DMERCs") are handled by four regional carriers.
These Service Carriers and DMERCs routinely review the billing practices and
procedures of health care providers and during such reviews these Carriers often
temporarily suspend all reimbursement payments to the providers whether or not
related to the billing issue being reviewed.
Currently, there are two DMERCs and two Service Carriers that have
notified a DCM that a review is being conducted and that Medicare claims are
being held in suspense pending such review. In addition, the Company is aware
that the Federal Bureau of Investigation is continuing to review certain aspects
of its operations and Medicare billing practices. System-wide, the total amount
of billings under suspension as of September 30, 1998 was approximately
$656,162.
The Company is fully cooperating in the DMERC and Service Carrier
reviews, and believes that its billing practices and procedures are proper. One
earlier review by another DMERC has been concluded and the amounts suspended
have been released to the Company. However, in the event the other carriers were
to disallow the reimbursement requests under review, some or all of the
suspended payments would not be collected. In addition, depending upon the
particular facts and circumstances involved in the review, the carriers could
seek repayment of prior reimbursements and deny reimbursement for such claims in
the future. Under certain circumstances, the submission of improper Medicare
reimbursement claims can result in civil and criminal penalties and
disqualification from seeking any reimbursement from Medicare in the future.
The current or future investigations could result in the presently
suspended reimbursement payments being denied, future suspensions being imposed,
criminal or civil fines or penalties being levied, or permanent denial of
Medicare reimbursement being imposed. Any of these events could have a material
adverse effect on the Company's financial condition and its ability to continue
to operate.
The Company conducted an internal review of the matters that have been
raised by the carriers and believes that these pending reviews and inquiries
will be concluded without any material adverse effect on the Company.
Corporate Practice of Medicine. Most states limit the practice of
medicine to licensed individuals or professional organizations comprised of
licensed individuals. Many states also limit the scope of business relationships
between business entities such as the Company and licensed professionals and
professional corporations, particularly with respect to fee-splitting between a
physician and another person or entity and non-physicians exercising control
over physicians engaged in the practice of medicine. Most of the Centers are
organized as professional corporations -- entities authorized to employ
physicians -- so as to comply with state statutes and state common law
prohibiting the corporate practice of medicine. Because the laws governing the
corporate practice of medicine vary from state to state and the application of
those laws is often ambiguous, any expansion of the operations of the Company to
a state with strict corporate practice of medicine laws, or the application of
these laws in states with existing Centers, may require the Company to modify
its operations with respect to one or more Centers, which could result in
increased financial risk to the Company. Further, there can be no assurance that
the Company's arrangements will not be successfully challenged as constituting
the unauthorized practice of medicine or that certain provisions of its services
agreements with the Centers (the "Services Agreements"), options to designate
ownership of the professional corporations, employment agreements with
physicians or covenants not to compete will be enforceable. Alleged violations
of the corporate practice of medicine doctrine have also been used successfully
by physicians to declare a contract to be void as against public policy. There
can be no assurance that a state or
16
professional regulatory agency would not attempt to revoke or suspend a
physician's license or the corporate charter or license of a professional
corporation owning a Center or the corporate charter of the Company or one of
its subsidiaries.
In October 1997, the Company was notified that the California State
Board of Medical Examiners was investigating several physicians and centers in
California for which the Company provides management services related to alleged
infractions of the state corporate practice of medicine rules. The California
State Board of Medical Examiners has referred the investigation to the
California Attorney General's office and no assessments have been proposed. The
Company is fully cooperating in this review and believes that the pending review
will be concluded without material adverse effect on the Company. Due to the
weak market demand, the Company closed the California clinics in late June 1998.
Dependence on Rigiscans; Potential Impact of Innovations. Rigiscan
patient monitoring devices accounted for approximately 24% of the centers'
revenues for the quarter ended September 30, 1998. As a consequence, any
material adverse development with respect to the Rigiscan devices, limitation in
the availability of such devices or material increase in the costs of such
devices could have a material adverse effect on the financial condition and
results of operations of the Company. In addition, innovations in diagnostic
tools and treatments for male sexual dysfunction (such as the recent
introduction of Viagra(R) ) or changes in reimbursement practices by third party
payors for such diagnostic tools and therapies could have a material adverse
effect on the financial condition and results of operations of the Company.
The Company has recently been informed by certain Medicare carriers
that under their interpretation of Medicare policies, these carriers intend to
limit the circumstances for coverage of certain diagnostic testing for
impotence. Although the Company intends to appeal these carriers'
interpretation, if it is determined that the Company will no longer be
reimbursed for these services, the loss of revenue could have a material adverse
effect on the Company's financial condition and results of operations.
In March 1998, the FDA approved Viagra(R) (Pfizer), the first oral
medication approved for use in the treatment of impotence. The Company
anticipates that the revenue generated for diagnosis, testing and treatment of
impotence with Viagra(R) will be lower than historical levels on a per patient
basis. As the treatment has only been available for a few months, the ultimate
impact on the Company's patient volume, revenue and earnings is unknown.
However, the impact could be materially adverse.
Competition. Competition in the diagnosis and treatment of impotence
stems from a wide variety of sources. The Centers face competition from
urologists, general practitioners, internists and other primary care physicians
who treat impotent patients, as well as hospitals, physician practice management
companies ("PPMs"), HMOs and non-physician providers of services related to
sexual dysfunction. If federal or state governments enact laws that attract
other health care providers to the male sexual dysfunction market, the Company
may encounter increased competition from other parties which seek to increase
their presence in the managed care market and which have substantially greater
resources than the Company. Any of these providers, many of which have far
greater resources than the Company, could adversely affect the Centers or
preclude the Company from entering those markets that can sustain only limited
competition. There can be no assurance that the Centers will be able to compete
effectively with their competitors, or that additional competitors will not
enter the market.
There are also many companies that provide management services to
medical practices, and the management industry continues to evolve in response
to pressures to find the most cost-effective method of providing quality health
care. There can be no assurance that the Company will be able to compete
effectively with its competitors, that additional competitors will not enter the
market, or that such
17
competition will not make it more difficult to acquire the assets of, and
provide management services for, medical practices on terms beneficial to the
Company.
Developing Market; Uncertain Acceptance of the Company's Services. Over
90% of new patient visits result from the Company's direct-to-patient
advertising. The market for the Company's services has only recently begun to
develop, and there can be no assurance that the public will accept the Company's
services on a widespread basis. The Company's future operating results are
highly dependent upon its ability to continually attract new patients. There can
be no assurance that demand for the Company's services will continue in existing
markets, or that it will develop in new markets. The Company makes significant
expenditures for advertising, and there can be no assurance that such
advertising will be effective in increasing market acceptance of, or generating
demand for, the Company's services. Failure to achieve widespread market
acceptance of the Company's services or to continually attract new patients
could have a material adverse effect on the Company's financial condition and
results of operations.
18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 2, 1998, Principal Mutual Life Insurance Company, an Iowa
Corporation, filed a complaint against the Company for damages
for breach of lease of $533,491.00 plus $10,000.00 legal fees in
the Superior Court for the State of California for the County of
San Diego.
On July 10, 1998, Campbell-Gateway Square filed a complaint for
breach of lease and damages in the Superior Court of California
in and of the County of Santa Clara.
On August 5, 1998, Wheat Ridge Bank Building Limited Partnership,
filed a complaint against the Company for rent and other charges,
plus attorney's fees in the sum of $13, 032.66 in the District
Court of Jefferson County, Colorado.
On August 26, 1998, Claude C. Arnold, Trustee of the Claude C.
Arnold Rovocable Living Trust and Blake C. Arnold (d/b/a
Doolittle Property), Successors in Interest to Northwest Medical
Center, Ltd., filed a complaint for breach of lease of
$306,598.77 in the District Court of Oklahoma County, State of
Oklahoma.
On September 21, 1998, Cotton Ltd., a California Limited
Partnership filed a complaint against the Company for rent and
damages in excess of $538,168.10 in the Superior Court of the
State of California for the County of Los Angeles.
On October 15, 1998, Saddleback Valley Medical Center filed a
complaint for breach of lease and damages in the Superior Court
of the State of California for the County of Orange for the sum
of $508,041.39.
On October 22, 1998, Oxford Construction Corporation, a Nevada
Corporation, filed a complaint for breach of lease and damages of
$373,245.00 in the District Court of Clark County, Nevada.
In addition, one recruiting services provider, one newspaper, and
one advertising firm have also filed lawsuits for payment of
services rendered in the aggregate amount of $190,033.75.
On November 12, 1998, the Company announced that it has filed for
protection under Chapter 11 of the U.S. Bankruptcy Code. In
addition, the planned merger with Century Medical Group was
canceled.
19
ITEM 2. CHANGES IN SECURITIES
The following sets forth all sales of unregistered securities
by the Company for the quarter ended September 30, 1998. The
Company relied on Section 4(2) of the Securities Act of 1933
for an exemption in each such case:
On July 15, 1998, the Company issued $2,000,000 of Series A
Convertible Preferred Stock. The Company issued 2,000
Preferred Shares at $1,000 per share with cumulative dividends
of $50 per share per annum (a 5% dividend), payable quarterly.
The dividends are payable in cash, or shares of Preferred
Stock in certain circumstances. Phillip Louis Trading Inc.
acted as the principal underwriter. The Company received
$1,792,829 from this transaction.
The Preferred Shares are redeemable by the Company, at its
option, at the following rates: (i) $1,150 per share if
redeemed on or before December 12, 1998; (ii) $1,175 per share
if redeemed on or between December 13, 1998 and January 11,
1999; and (iii) $1,200 per share if redeemed on or after
January 12, 1999, plus all accrued and unpaid dividends, upon
five days prior notice. The Company may, at its option, cause
all outstanding Preferred Shares to be converted into Common
Stock at any time beginning on July 1, 2000, on at least
twenty days' advance notice at the conversion rate described
in the next paragraph.
The Preferred Shares are convertible to common stock at the
holder's option at any time. The conversion rate is the lower
of $4.00 or an increasing discount from the average closing
price five days prior to conversion. The conversion discount
is 15% through December 12, 1998; 17.5% from that day through
January 11, 1999; and 20% thereafter.
The Preferred Shares are non-voting shares and are subject to
certain other terms and provisions. The Company has agreed to
file a registration statement covering the common stock
underlying the Preferred Shares before September 15, 1998.
Additionally, at an aggregate purchase price of $2.00, the
Company issued to the new investor warrants to purchase 20,000
shares of common stock par value $.001 per share, at an
exercise price of $4.05 per share.
On July 15, 1998, a Stock Purchase Agreement was signed with
Wellteck Medical Network, Inc. ("Wellteck") of Richmond,
Virginia. Wellteck manages a single affiliated medical
facility, doing business as Richmond Medical Center for Men,
and a blood testing lab. On September 8, 1998, the Company
completed the transaction of purchasing all outstanding shares
of Wellteck in exchange for 411,000 shares of the Company's
common stock at $2.00 per share.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Not Applicable
20
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS REQUIRED TO BE FILED BY ITEM 601 OF REGULATION S-B
4(p) Form of the Note and Warrant Agreement used by the
Company in favor of Institutional Venture Management VI
Limited Partnership, IVP Founders Fund I, Institutional
Venture Management VI, and Frazier Healthcare II, L.P., in the
principal amount of $800,000 dated June 30, 1998.
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
On July 28, 1998, the Company reported that on July 15, 1998
$2,000,000 of Series A Convertible Preferred Stock was issued
to ProFutures Special Equities Fund, L.P., a Delaware Limited
Partnership.
21
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
INTEGRATED MEDICAL RESOURCES, INC.
Date: November 16, 1998 By: /s/ Dr. E. Stanley Kardatzke
----------------------------
Dr. E. Stanley Kardatzke
Chairman and Chief Executive Officer
By: /s/ Janel E. Chilson
Janel E. Chilson
Chief Accounting Officer
(Authorized Officer and Principal
Financial and Accounting Officer)
22