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 June 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 July 31, 1998, there were 10,027,028 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
- -------------------------------------------------------------------------------
June 30, December 31,
ASSETS 1998 1997
(unaudited)
----------- ------------
CURRENT ASSETS:
Cash and cash equivalents $ 439,443 $ 765,204
Accounts receivable, less allowance of $2,312,647
in 1998 and $2,074,660 in 1997 7,833,596 8,411,413
Supplies 402,841 407,071
Prepaid expenses 308,993 101,640
----------- -----------
Total current assets 8,984,873 9,685,328
NON-CURRENT ASSETS:
Property and equipment:
Furniture, fixtures and equipment 8,348,641 8,351,703
Leasehold improvements 165,718 151,836
----------- -----------
8,514,359 8,503,539
Accumulated depreciation 3,616,869 2,801,377
----------- -----------
4,897,490 5,702,162
Intangible assets 156,254 182,843
Other assets 295,927 239,439
----------- -----------
TOTAL ASSETS $14,334,544 $15,809,772
=========== ===========
See accompanying notes to financial statements
===============================================================================
1
===============================================================================
INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Continued)
- -------------------------------------------------------------------------------
June 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
(unaudited)
------------ ------------
CURRENT LIABILITIES:
Accounts payable $ 2,682,167 $ 3,793,008
Accrued payroll 690,883 647,582
Accrued advertising 970,309 773,468
Accrued restructuring charge 528,293 628,120
Other accrued expenses 91,954 188,980
Working capital line of credit 2,429,900 3,085,954
Current portion of long-term debt 1,786,207 2,685,491
Current portion of capital lease obligations 180,558 245,684
------------ ------------
Total current liabilities 9,360,271 12,048,287
NON-CURRENT LIABILITIES:
Deferred rent 209,289 195,748
Long-term debt, less current portion 602,027 1,325,282
Capital lease obligations, less current portion 61,127 139,898
------------ ------------
Total non-current liabilities 872,443 1,660,928
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value:
Authorized shares - 1,696,698
Issued and outstanding shares - none -- --
Common stock, $.001 par value:
Authorized shares - 25,000,000
Issued and outstanding shares - 10,027,029 10,026 6,731
Treasury stock, at cost (11,347) (11,347)
Additional paid-in capital 25,092,306 18,219,781
Accumulated deficit (20,989,155) (16,114,608)
------------ ------------
Total stockholders' equity 4,101,830 2,100,557
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 14,334,544 $ 15,809,772
============ ============
See accompanying notes to financial statements
===============================================================================
2
INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
===============================================================================================================
For the three months For the six months
ended ended
June 30 June 30
------------------------------------------------------------
1998 1997 1998 1997
------------------------------------------------------------
NET REVENUE: $ 3,488,064 $ 5,066,132 $ 8,821,626 $ 9,121,999
Center operating expenses:
Physician salaries 868,415 929,924 1,730,847 1,826,327
Cost of services 837,820 1,045,169 1,696,958 1,908,870
Center staff salaries 504,912 560,992 1,024,184 1,108,109
Center facilities rent 295,301 349,223 590,344 673,365
Bad debt expense 675,971 111,160 1,081,223 194,338
------------------------------------------------------------
Total center operating expenses 3,182,419 2,996,468 6,123,556 5,711,009
------------------------------------------------------------
Center contribution 305,645 2,069,664 2,698,070 3,410,990
------------------------------------------------------------
CORPORATE EXPENSES:
Advertising 1,383,232 1,343,944 2,387,692 2,706,206
Selling, general and administrative 1,969,929 1,467,112 3,533,555 2,719,686
Depreciation and amortization 443,394 545,080 932,387 1,103,025
Restructuring charge 243,423 --- 243,423 ---
------------------------------------------------------------
Total corporate expenses 4,039,978 3,356,136 7,097,057 6,528,917
------------------------------------------------------------
Operating loss (3,734,333) (1,286,472) (4,398,987) (3,117,927)
------------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest income --- 39,163 3,175 100,733
Interest expense (232,419) (100,602) (478,735) (178,629)
Other --- 1,813 --- 8,353
------------------------------------------------------------
(232,419) (59,626) (475,560) (69,543)
------------------------------------------------------------
NET LOSS $ (3,966,752) $ (1,346,098) $ (4,874,547) $ (3,187,470)
------------------------------------------------------------
Net loss per common share -- basic and diluted $ (.46) $ (.20) $ (.64) $ (.47)
------------------------------------------------------------
Basic and diluted weighted average common
shares outstanding 8,556,216 6,715,017 7,649,964 6,715,017
============================================================
===============================================================================================================
See accompanying notes to financial statements
3
INTEGRATED MEDICAL RESOURCES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
=====================================================================================================================
For the six months ended
June 30
---------------------------------------
1998 1997
---------------------------------------
OPERATING ACTIVITIES:
Net loss $(4,874,547) $(3,187,470)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 841,327 624,938
Amortization 91,060 478,087
Provision for bad debts 237,987 215,073
Deferred rent 13,541 ---
Pre-opening costs incurred --- (111,935)
Changes in operating assets and liabilities:
Accounts receivable 339,830 (1,832,554)
Supplies 4,230 (122,392)
Prepaid expenses (207,353) (6,258)
Accounts payable (1,110,841) (639,027)
Accrued payroll 43,301 (3,380)
Accrued advertising 196,841 (13,714)
Other accrued expenses (196,853) 169,404
--------------------------------------
Net cash used in operating activities (4,621,477) (4,429,228)
--------------------------------------
INVESTING ACTIVITIES:
Purchases of property and equipment (34,204) (341,424)
Other (96,001) (166,030)
--------------------------------------
Net cash used in investing activities (130,205) (507,454)
--------------------------------------
FINANCING ACTIVITIES:
Principal payments on line of credit (656,054) ---
Borrowings on line of credit --- 1,710,000
Proceeds from issuance of convertible debt 300,000 ---
Principal payments on long-term debt (648,693) (456,804)
Debt issuance costs incurred (27,409) ---
Net principal payments on capital lease obligations (143,897) (175,024)
Proceeds from issuance of common stock 5,601,974 ---
--------------------------------------
Net cash provided by financing activities 4,425,921 1,078,172
--------------------------------------
Net decrease in cash and cash equivalents (325,761) (3,858,510)
Cash and cash equivalents at beginning of period 765,204 6,739,697
--------------------------------------
Cash and cash equivalents at end of period $ 439,443 $ 2,881,187
======================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid for interest $ 281,301 $ 165,093
SUPPLEMENTAL SCHEDULE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Additions to property and equipment through issuance of long
term debt --- $ 492,000
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 June 30, 1998, the
Company managed 23 diagnostic clinics operated under the name The Diagnostic
Center for Men in 16 states (collectively the "Centers"). Each of those 23
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.
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
six month periods ended June 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 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.
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
5
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 of
Men, and a blood testing lab. The purchase price will be paid with shares of
the Company's common stock and will be determined upon closing of the
acquisition based on various factors and based on the clinic's performance. In
connection with the transaction, Richard J. Altier has entered into a three-year
employment agreement. The closing of the transaction is expected to occur in
the third quarter.
On July 15, 1998, a Stock Purchase Agreement was signed with Century
Medical Group, Inc. ("Century") of Mobile, Alabama. Century manages six
affiliated medical clinics located in Mobile, Birmingham, and Montgomery, AL,
Biloxi and Jackson, MS and Little Rock, AR doing business as the Men's Health
Center. The purchase price will be paid with shares of the Company's common
stock and will be determined upon closing of the acquisition based on various
factors and based on the clinic's performance. The closing of the transaction
is expected to occur in the third quarter.
On July 17, 1998 a purchase agreement was signed with Arizona Advanced
Vascular, Ltd. ("AAVL"). AAVL manages 14 affiliated clinics in four states:
six clinics in its Phoenix headquarters region, four in Pittsburgh, three in
Boston and one in Salt Lake City. The purchase will be paid with a combination
of cash and shares of the Company's common stock and will be based on the
clinic's performance. In consideration of a three-year convenant not to
compete, Dr. Bruce Love was paid $125,000. The closing of the transaction is
expected to occur in the third quarter.
6
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
June 30, 1998, the Company manages 23 Centers in 16 states.
For the three and six months ended June 30, 1998, approximately 75% and
74%, respectively, of patient billings were covered by medical insurance plans
subject to applicable deductible and other co-pay provisions paid by the
patient. Approximately 26% and 28%, respectively, of patient billings were
covered by Medicare and 48% and 47%, 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.
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 six months
ended June 30 ended June 30
-------------------------------------------
1998 1997 1998 1997
-------------------------------------------
Net revenue 100.0% 100.0% 100.0% 100.0%
Center operating expenses:
Physician salaries 24.9 18.4 19.6 20.0
Cost of services 24.0 20.6 19.2 20.9
Center staff salaries 14.5 11.1 11.6 12.1
Center facilities rent 8.5 6.9 6.7 7.4
Bad debt expense 19.4 2.2 12.3 2.1
-------------------------------------------
Total center operating expenses 91.2 59.1 69.4 62.6
-------------------------------------------
Center contribution 8.8 40.9 30.6 37.4
Corporate expenses:
Advertising 39.7 26.5 27.1 29.7
Selling, general and administrative 56.5 29.0 40.1 29.8
Depreciation and amortization 12.7 10.8 10.6 12.1
Restructuring charge 7.0 0.0 2.8 0.0
-------------------------------------------
Total corporate expenses 115.8 66.2 80.5 71.6
-------------------------------------------
Operating loss (107.1) (25.4) (49.9) (34.2)
Interest expense, net (6.7) (1.2) (5.4) (0.8)
-------------------------------------------
Net loss (113.7) (26.6) (55.3) (34.9)
====================================================================================
7
Three Months Ended June 30, 1998 and 1997
- -----------------------------------------
Net Revenue. Net revenue decreased approximately 31% from $5,066,132 in
1997 to $3,488,064 in 1998 due to a decline in the number of new patients seen
and also to a significant decrease in diagnostic revenue per new patient.
Revenue per new patient fell sharply at the beginning of the quarter due to a
decline in the utilization of diagnostic testing resulting from the introduction
of a new oral medication for the treatment of impotence (Viagra(R) by Pfizer).
Viagra's(R) release caused what the Company believes to be a transient but
significant influx of new patients seeking Viagra(R) but not wishing to pursue a
diagnosis for their symptom of impotence. In addition, the decline in net
revenue can secondarily be attributed to a decrease in the number of clinics
under management from the previous year. The Company had 28 clinics operating
under the name The Diagnostic Center for Men during the second quarter 1998,
compared with 33 clinics during the same quarter 1997.
Physician Salaries. Physician salaries decreased approximately 7% from
$929,924 in 1997 to $868,415 in 1998 due to the closing of five clinics in
December 1997. Due to the decreased net revenue for the second quarter 1998,
physician salaries increased as a percentage of net revenue from 18.4% in 1997
to 24.9% 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, decreased approximately
20% from $1,045,169 in 1997 to $837,820 in 1998 due to the decline in number of
patients seen and the closing of five Centers in the fourth quarter 1997. As a
percentage of net revenue, cost of services increased from 20.6% to 24.0%.
Center Staff Salaries. Center staff salaries decreased approximately 10%
from $560,992 in 1997 to $504,912 in 1998 due primarily to the closing of five
clinics in December 1997. As a percentage of net revenue, center staff salaries
increased from 11.1% to 14.5%, due to decreased revenues during the second
quarter of 1998.
Center Facilities Rent. Center facilities rent decreased approximately 15%
from $349,223 in 1997 to $295,301 in 1998 due to the closing of five clinics in
December 1997. As a percentage of net revenue, center facilities rent increased
from 6.9% to 8.5%, due to decreased revenues in the Centers.
Bad Debt Expense. Bad debt expense increased by $564,811 from $111,160 to
$675,971. 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 85% from
$2,069,664 in 1997 to $305,645 in 1998 due to the decrease in net revenue. The
center operating expenses, excluding bad debts, decreased by approximately 13%,
however, this decrease of $379,000 was offset by the increase in the bad debt
expense of $565,000.
Advertising. Advertising expense increased approximately 3% from $1,343,944
in 1997 to $1,383,232 in 1998 mainly due to the production of a series of three
new TV commercials featuring Len
8
Dawson, NFL Hall of Fame Member and prostate cancer survivor, as our national
spokesman. In addition, several advertising tests were implemented during May
and June of 1998. These tests would not only be used to project results and
efficiencies of national vs. regional advertising strategies, but to identify
possible expansion markets. As a percentage of net revenue, advertising expense
increased from 26.5% in 1997 to 39.7% in 1998, due to decreased revenues during
the second quarter of 1998.
Depreciation and Amortization. Depreciation and amortization decreased
approximately 19% from $545,080 in 1997 to $443,394 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 10.8% to 12.7%.
Selling, General and Administrative. Selling, general and administrative
expense increased approximately 34% from $1,467,112 in 1997 to $1,969,929 in
1998 due to legal, accounting, and consulting costs related to the pursuance of
additional financing and clinic mergers and acquisitions. In addition, severance
costs were incurred related to corporate executive resignations and recruitment
fees were expended to locate new physicians to staff existing clinics. As a
percentage of net revenue, selling, general and administrative expense increased
from 29.0% to 56.5%.
Restructuring Charge. A restructuring charge of $243,423 was a result of
expenses for closing clinics at the end of June 1998. Additional expenses for
the closed clinics will be incurred during the third quarter.
Interest Expense, Net. Interest expense increased from $59,626 in 1997
to $232,419 in 1998, as the Company utilized its working capital line of credit
to fund cash flow deficits resulting from operating losses and continued high
levels of accounts receivable. Additionally, the Company recognized interest
expense resulting from the $1.4 million convertible subordinated promissory
notes and attached warrants issued in December 1997 (the Stockholder Loan), from
the $1.6 million convertible note issued in March 1998 (the KMI Financing), and
from $1,210,000 of convertible notes (KMI additional financing) and $1,531,875
of convertible notes (additional stockholder loans) issued in May 1998. The
convertible notes were converted to common stock at the end of May as a result
of the approval by shareholders at the annual meeting held on May 29, 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.
9
Six Months Ended June 30, 1998 and 1997
- ---------------------------------------
Net Revenue. Net revenue decreased approximately 3% from $9,121,999 in
1997 to $8,821,626 in 1998 due to the decline in net revenues during the second
quarter 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 half 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 5% from
$1,826,327 in 1997 to $1,730,847 in 1998 due to the closing of five clinics in
December 1997. As a percentage of net revenue, physician salaries decreased from
20.0% to 19.6%.
Cost of Services. Cost of services expenses decreased approximately 11%
from $1,908,870 in 1997 to $1,696,958 in 1998 due to the closing of five clinics
in the fourth quarter 1997. As a percentage of net revenue, cost of services
decreased from 20.9% to 19.2%, primarily as a result of the elimination of the
greater expenses compared to revenues of the seven clinics closed in the fourth
quarter 1997.
Center Staff Salaries. Center staff salaries decreased approximately 8%
from $1,108,109 in 1997 to $1,024,184 in 1998 due primarily to the closing of
five clinics in December 1997. As a percentage of net revenue, center staff
salaries decreased from 12.1% to 11.6%.
Center Facilities Rent. Center facilities rent decreased approximately 12%
from $673,365 in 1997 to $590,344 in 1998 due primarily to the closing of five
clinics in December 1997. As a percentage of net revenue, center facilities rent
decreased from 7.4% to 6.7% due to the large number of clinics opened in early
1997.
Bad Debt Expense. For the reasons described above, bad debt expense
increased by $886,885 from $194,338 to $1,081,223.
Center Contribution. Center contribution decreased by 21% from $3,410,990
to $2,698,070. The net revenue decreased by 3% or $300,000. The clinic operating
expenses, excluding bad debts, decreased by approximately 9%, however, this
decrease of $470,000 was offset by the increase in the bad debt expense of
$890,000.
Advertising. Advertising expense decreased approximately 12% from
$2,706,206 in 1997 to $2,387,692 in 1998 due mainly to 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 decreased from 29.7% to
27.1%.
Depreciation and Amortization. Depreciation and amortization decreased
approximately 15% from $1,103,025 in 1997 to $932,387 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 decreased from 12.1% to 10.6%, due
primarily to reduced expense. Pre-opening costs are amortized over a 12-month
period.
Selling, General and Administrative. Selling, general and administrative
expense increased approximately 30% from $2,719,686 in 1997 to $3,533,555 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
10
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 29.8% to
40.1%, 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 $69,543 in 1997 to $475,560 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 six 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, as well as an infusion of equity of $4.2 million during the second
quarter and $2.8 million in March.
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 a diagnosis for their symptom of impotence,
revenues for the second quarter decreased due to lower new 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 1998. In addition, the
Company is enhancing its advertising program, eliminating inefficiencies in the
way the Company is managed, and redirecting strategies to enhance patient
revenues. The Company is 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 June
30, 1998, the Company had $2,430,190 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 June 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 $2,000,000 of Series A Convertible
Preferred Stock. See "Subsequent Events."
At June 30, 1998, the Company had cash and cash equivalents of $439,000.
Accounts receivable, net of allowance, decreased $577,817, from $8,411,413 at
December 31, 1997 to $7,833,596 at June 30, 1998. The decrease in accounts
receivable is primarily due to decreases in net revenue and bad debt write-offs.
The June 30, 1998 amount includes $209,000 recently submitted for Medicare
reimbursement after completion of appropriate provider registration requirements
or pending submission awaiting completion of those requirements, which the
Company anticipates will be completed by the third quarter 1998. In addition,
$638,000 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 sources although there can be no assurance that any such funds
can be obtained. The Company believes that funds available under the Company's
line of credit, operating cash flows generated, especially if collections of
accounts receivable improve, proceeds from issuance of the Preferred Shares, and
proceeds
12
of the conversion of additional options by KMI, IVP and Frazier, if any, when
combined with the additional financing being sought, will be sufficient 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 third quarter of 1998 through the second 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.
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.
13
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 by Third Party Payors. For the quarter ended
June 30, 1998, approximately 75% of patient billings were covered by medical
insurance plans subject to applicable deductibles and other co-pay provisions
paid by the patient. Approximately 26% of patient billings were covered by
Medicare and 48% 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 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
14
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.
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 June 30, 1998 was approximately $395,000.
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
15
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 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 23% of the centers' revenues for
the quarter ended June 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.
16
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 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.
17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 18, 1998, Draft Worldwide, Inc. ("Draft Worldwide") filed a
complaint against the Company for breach of contract. The parties have
reached a verbal agreement and are in the process of drafting a written
agreement to settle this dispute which requires the Company to pay
$325,000 by the end of the year in two installments payable upon
receipt of future financing.
After the end of the quarter, two landlords and one ex-employee filed
lawsuits arising from the earlier announced closing of clinics and one
recruiting services provider has filed a lawsuit for payment of
services rendered. The Company intends to vigorously defend these
lawsuits.
ITEM 2. CHANGES IN SECURITIES
The following sets forth all sales of unregistered securities by the
Company for the quarter ended June 30, 1998. No underwriters were
involved in any sale, nor were any commissions or similar fees paid by
the Company with respect thereto. The Company relied on Section 4(2) of
the Securities Act of 1933 for an exemption in each such case:
On April 17, 1998, Dr. E. Stanley Kardatzke joined the Company as Chief
Executive Officer and Chairman of the Board of Directors. In
conjunction with his joining, the convertible note with Kardatzke
Management, Inc. was converted to common stock and an option to
purchase additional shares of common stock was exercised. This
transaction resulted in a capital infusion of $2,375,000 and the
issuance of 1,104,650 shares of common stock. In addition, Dr.
Kardatzke, upon joining the Company, received options to purchase an
aggregate 600,000 shares of common stock at a purchase price of $2.15
per share, vesting over four years.
On May 29, 1998, at the annual meeting of shareholders, the
shareholders approved certain transactions whereby the conversion of
notes and exercise of options resulted in a capital infusion of
approximately $4.2 million and the issuance of 1,926,451 shares of
common stock. Of these shares, 562,792 were issued to Kardatzke
Management, Inc. and the remaining 1,363,659 were issued to
IVP/Frazier, in satisfaction of convertible loans.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
On May 29, 1998, at the annual meeting of shareholders, the
shareholders approved a) the election of Dwayne R. Sigler and Samuel D.
Colella, Class II Directors, to serve, in each case, for a term of
three years; b) the ratification and approval of a transaction with
Kardatzke Management, Inc. ("KMI"), whereby KMI loaned the Company
$1,600,000 in exchange for a note convertible into 744,186 shares of
Common Stock of the Company and related options to purchase Common
Stock and entered into a management consulting agreement with the
Company; and c) an amendment to the
18
Amended and Restated Articles of Incorporation of the Company which
increased the authorized number of shares of the Company's Common Stock
from 10,000,000 shares to 25,000,000 shares.
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(m) Note and Warrant Agreement by the Company in favor of E.
Stanley Kardatzke, Trustee of the E. Stanley Kardatzke Revocable
Trust, in the original principal amount of $300,000 dated July 1,
1998.
4(n) Stock Purchase Warrant by the Company in favor of E. Stanley
Kardatzke, Trustee of the E. Stanley Kardatzke Revocable Trust,
dated July 1, 1998.
4(o) Convertible Subordinated Promissory Note by the Company in favor
of E. Stanley Kardatzke, Trustee of the E. Stanley Kardatzke
Revocable Trust, dated July 1, 1998.
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
On April 14, 1998, the Company filed Form 8-K reporting under Item 5,
Other Events, announcing Dr. Kardatzke joined the Company in the
capacity of Chief Executive Officer and Chairman of the Board of
Directors. Dr. Kardatzke loaned the Company $1,600,000 which were later
converted to 744,186 Shares of Common Stock. In addition, Dr. Kardatzke
exercised options to purchase an additional 593,022 Shares of Common
Stock. These transactions resulted in a capital infusion of $2,875,000.
19
On April 28, 1998, the Company filed Form 8-K reporting under Item 5,
Other Events, the amendments made to the financing arrangements
referred to in the Form 8-K filed on April 14, 1998.
On June 10, 1998, the Company filed Form 8-K reporting under Item 5,
Other Events, the approval by shareholders at the annual meeting of
certain equity transactions whereby the conversion of notes and
exercise of options resulted in a capital infusion of approximately
$4.2 million and the issuance of 1,926,451 shares of common stock.
Unaudited balance sheets of the Company at March 31, 1998 and April 30,
1998 and a proforma balance sheet as of April 30, 1998 was filed with
the Form 8-K.
20
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: August 14, 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)
21