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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2005
OR
[ ] 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 0-19019
PRIMEDEX HEALTH SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
NEW YORK 13-3326724
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1510 COTNER AVENUE
LOS ANGELES, CALIFORNIA 90025
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(310) 478-7808
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED
SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 of 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the registrant's common stock as of
September 13, 2005 was 41,406,813 (excluding treasury shares).
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PART 1 -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED BALANCE SHEETS
JULY 31,
2005 OCTOBER 31,
(UNAUDITED) 2004
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,000 $ 1,000
Accounts receivable, net 19,809,000 20,029,000
Unbilled receivables and other receivables 771,000 966,000
Other 1,899,000 1,858,000
------------- -------------
Total current assets 22,481,000 22,854,000
------------- -------------
PROPERTY AND EQUIPMENT, NET 71,037,000 77,333,000
------------- -------------
OTHER ASSETS
Accounts receivable, net 1,847,000 1,868,000
Goodwill 23,099,000 23,099,000
Trade name and other 4,097,000 2,297,000
------------- -------------
Total other assets 29,043,000 27,264,000
------------- -------------
Total assets $ 122,561,000 $ 127,451,000
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Cash disbursements in transit $ 3,790,000 $ 2,536,000
Accounts payable and accrued expenses 21,501,000 22,852,000
Revolving line of credit 11,613,000 14,011,000
Current portion of notes and leases payable 19,002,000 15,627,000
------------- -------------
Total current liabilities 55,906,000 55,026,000
------------- -------------
LONG-TERM LIABILITIES
Subordinated debentures payable 16,147,000 16,147,000
Notes payable to related party 3,499,000 2,119,000
Notes and leases payable, net of current portion 116,056,000 121,385,000
Accrued expenses 1,282,000 329,000
------------- -------------
Total long-term liabilities 136,984,000 139,980,000
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT (70,329,000) (67,555,000)
------------- -------------
Total liabilities and stockholders' deficit $ 122,561,000 $ 127,451,000
============= =============
The accompanying notes are an integral part of these financial statements
2
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, 2004 2005 2004 2005
- -------- ------------- ------------- ------------- -------------
NET REVENUE $ 33,900,000 $ 36,178,000 $ 103,800,000 $ 105,478,000
OPERATING EXPENSES
Operating expenses 27,039,000 26,790,000 79,401,000 79,792,000
Depreciation and amortization 4,453,000 4,243,000 13,295,000 12,905,000
Provision for bad debts 1,328,000 946,000 3,984,000 2,789,000
Loss on disposal of equipment, net -- -- -- 698,000
------------- ------------- ------------- -------------
Total operating expenses 32,820,000 31,979,000 96,680,000 96,184,000
------------- ------------- ------------- -------------
INCOME FROM OPERATIONS 1,080,000 4,199,000 7,120,000 9,294,000
OTHER EXPENSE (INCOME)
Interest expense 4,692,000 4,278,000 13,147,000 12,788,000
Other income (70,000) (42,000) (141,000) (688,000)
Other expense 741,000 -- 1,587,000 25,000
------------- ------------- ------------- -------------
Total other expense 5,363,000 4,236,000 14,593,000 12,125,000
------------- ------------- ------------- -------------
LOSS BEFORE MINORITY INTEREST (4,283,000) (37,000) (7,473,000) (2,831,000)
MINORITY INTEREST IN EARNINGS OF
SUBSIDIARIES (234,000) -- (246,000) --
------------- ------------- ------------- -------------
NET LOSS $ (4,517,000) $ (37,000) $ (7,719,000) $ (2,831,000)
============= ============= ============= =============
BASIC AND DILUTED NET LOSS PER SHARE $ (.11) $ -- $ (.19) $ (.07)
============= ============= ============= =============
WEIGHTED AVERAGE SHARES OUTSTANDING
Basis and diluted 41,106,813 41,207,900 41,106,813 41,137,405
============= ============= ============= =============
The accompanying notes are an integral part of these financial statements
3
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
NINE MONTHS ENDED JULY 31, 2005
COMMON STOCK $.01 PAR VALUE,
100,000,000 SHARES AUTHORIZED TREASURY STOCK, AT COST
----------------------------- PAID-IN ----------------------------- ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL SHARES AMOUNT DEFICIT DEFICIT
------------- ------------- ------------- ------------- ------------- ------------- -------------
BALANCE--
OCTOBER 31, 2004 42,931,813 $ 430,000 $ 100,536,000 (1,825,000) $ (695,000) $(167,826,000) $ (67,555,000)
Issuance of Common
Stock 300,000 3,000 54,000 -- -- -- 57,000
Net Loss -- -- -- -- -- (2,831,000) (2,831,000)
------------- ------------- ------------- ------------- ------------- ------------- -------------
BALANCE--
JULY 31, 2005
(UNAUDITED) 43,231,813 $ 433,000 $ 100,590,000 (1,825,000) $ (695,000) $(170,657,000) $ (70,329,000)
============= ============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these financial statements
4
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED JULY 31, 2004 2005
- -------------------------- ------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 13,349,000 $ 6,822,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (2,105,000) (2,831,000)
Purchase of subsidiary common stock (35,000) --
Proceeds from sale of equipment -- 65,000
------------ ------------
Net cash used by investing activities (2,140,000) (2,766,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash disbursements in transit (819,000) 1,254,000
Principal payments on notes and leases payable (11,974,000) (9,565,000)
Payments on line of credit -- (2,398,000)
Proceeds from issuance of convertible subordinated notes payable 1,000,000 --
Proceeds from short and long-term borrowings on notes payable 874,000 5,284,000
Proceeds from borrowings from related parties -- 1,370,000
Purchase of subordinated debentures (48,000) --
------------ ------------
Net cash used by financing activities (10,967,000) (4,055,000)
------------ ------------
NET INCREASE IN CASH 242,000 1,000
CASH, beginning of period 30,000 1,000
------------ ------------
CASH, end of period $ 272,000 $ 2,000
------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 7,727,000 $ 12,241,000
------------ ------------
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES
During the nine months ended July 31, 2004, we converted equipment
operating leases into capital leases and capitalized equipment of $6,220,000 and
financed additional equipment for $300,000. During the nine months ended July
31, 2005, we entered into additional capital leases for $4,781,000.
During the nine months ended July 31, 2004 and 2005, we accrued
interest on notes payable and capital lease obligations of approximately
$6,315,000 and $559.000, respectively. In fiscal 2004, we renegotiated our
existing notes and capital lease obligations with our three primary lenders,
General Electric ("GE"), DVI Financial Services and U.S. Bank extending terms
and reducing monthly payments on approximately $135.1 million of combined
outstanding debt. During this time, unpaid interest was accrued during the
period of renegotiation.
The accompanying notes are an integral part of these financial statements
5
PRIMEDEX HEALTH SYSTEMS, INC. AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
The consolidated financial statements of Primedex include the accounts of
Primedex, its wholly owned direct subsidiary, Radnet Management, Inc., or
Radnet, and Beverly Radiology Medical Group III, or BRMG, which is a
professional corporation, all collectively referred to as "us" or "we". The
consolidated financial statements also include Radnet Sub, Inc., Radnet
Management I, Inc., Radnet Management II, Inc., or Modesto, SoCal MR Site
Management, Inc., Diagnostic Imaging Services, Inc., or DIS, Burbank Advanced
LLC, or Burbank, and Rancho Bernardo Advanced LLC, or RB, all wholly owned
subsidiaries of Radnet. Interests of minority shareholders are separately
disclosed in the consolidated balance sheets and consolidated statements of
operations of the Company. Effective July 31, 2004 and September 30, 2004, we
purchased the remaining 25% minority interests in Rancho Bernardo and Burbank,
respectively.
The operations of BRMG are consolidated with us as a result of the contractual
and operational relationship among BRMG, Dr. Berger and us. We are considered to
have a controlling financial interest in BRMG pursuant to the guidance in EITF
97-2. Medical services and supervision at most of our imaging centers are
provided through BRMG and through other independent physicians and physician
groups. BRMG is consolidated with Pronet Imaging Medical Group, Inc. and Beverly
Radiology Medical Group, both of which are 99% owned by Dr. Berger. Radnet
provides non-medical, technical and administrative services to BRMG for which
they receive a management fee.
Operating activities of subsidiary entities are included in the accompanying
financial statements from the date of acquisition. All intercompany transactions
and balances have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X and, therefore, do not include all information and footnotes necessary for a
fair presentation of financial position, results of operations and cash flows in
conformity with accounting principles generally accepted in the United States
for complete financial statements; however, in the opinion of our management,
all adjustments consisting of normal recurring adjustments necessary for a fair
presentation of financial position, results of operations and cash flows for the
interim periods ended July 31, 2005 and 2004 have been made. The results of
operations for any interim period are not necessarily indicative of the results
for a full year. These interim consolidated financial statements should be read
in conjunction with the consolidated financial statements and related notes
thereto contained in our Annual Report on Form 10-K for the year ended October
31, 2004.
LIQUIDITY AND CAPITAL RESOURCES
We had a working capital deficit of $33.4 million at July 31, 2005 compared to a
$32.2 million deficit at October 31, 2004, and had losses from operations of
$37,000 and $4.5 million during the three months ended July 31, 2005 and 2004,
respectively, and had losses from operations of $2.8 million and $7.7 million
during the nine months ended July 31, 2005 and 2004, respectively. We also had a
stockholders' deficit of $70.3 million at July 31, 2005 compared to a $67.6
million deficit at October 31, 2004.
We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations. In addition to operations, we
require significant amounts of capital for the initial start-up and development
expense of new diagnostic imaging facilities, the acquisition of additional
facilities and new diagnostic imaging equipment, and to service our existing
debt and contractual obligations. Because our cash flows from operations are
insufficient to fund all of these capital requirements, we depend on the
availability of financing under credit arrangements with third parties.
Historically, our principal sources of liquidity have been funds available for
borrowing under our existing line of credit, now with Wells Fargo Foothill. Even
though the line of credit matures in 2008, we classify the line of credit as a
current liability primarily because it is collateralized by accounts receivable
and the eligible borrowing base is classified as a current asset. We finance the
acquisition of equipment mainly through capital and operating leases. As of July
31, 2005 and October 31, 2004, our line of credit liabilities were $11.6 million
and $14.0 million, respectively.
6
During the last twelve months, we took the actions described below to continue
to fund our obligations. In addition, some of our plans to provide the necessary
working capital in the future are summarized below.
BRMG and Wells Fargo Foothill are parties to a credit facility under which BRMG
may borrow the lesser of 85% of the net collectible value of eligible accounts
receivable plus one month of average capitation receipts for the prior six
months, two times the trailing month cash collections, or $20,000,000. Eligible
accounts receivable shall exclude those accounts older than 150 days from
invoice date and will be net of customary reserves. In addition, Wells Fargo
Foothill set up a term loan where they can advance up to the lesser of
$3,000,000 or 80% of the liquidation value of the equipment value servicing the
loan. Under this term loan, we borrowed $880,000 in February 2005 to acquire
medical equipment. The five-year term loan had interest only payments through
February 28, 2005 with the first quarterly principal payments due on April 1,
2005. Access to additional funds under the term loan expired soon after the
February 2005 draw.
Under the $20,000,000 revolving loan, an overadvance subline will be available
not to exceed $2,000,000, or one month of the average capitation receipts for
the prior six months, until June 30, 2005. From July 1 to September 30, 2005,
the overadvance subline will be available not to exceed $1,500,000, or one month
of the average capitation receipts for the prior six months. Beginning October
1, 2005, the maximum overadvance cannot exceed the lesser of $1,000,000 or one
month of the average capitation receipts for the prior six months. Also under
the revolving loan, we are entitled to request that Wells Fargo Foothill issue
guarantees of payment with respect to letters of credit issued by an issuing
bank in an aggregate amount not to exceed $5,000,000 at any one time
outstanding. At July 31, 2005, the prime rate was 6.25% and we had $4.5 million
of available borrowing under the Wells Fargo Foothill revolving loan.
Advances outstanding under the revolving loan bear interest at the base rate
plus 1.5%, or the LIBOR rate plus 3.0%. Advances under the overadvance subline
and term loan bear interest at the base rate plus 4.75%. Letter of credit fees
bear interest of 3.0% per annum times the undrawn amount of all outstanding
lines of credit. The base rate refers to the rate of interest announced within
Wells Fargo Bank at its principal office in San Francisco as it prime rate. The
line is collateralized by substantially all of our accounts receivable and
requires us to meet certain financial covenants including minimum levels of
EBITDA, fixed charge coverage ratios and maximum senior debt/EBITDA ratios as
well as limitations on annual capital expenditures.
Effective September 14, 2005, we established a new $20 million working capital
revolving credit facility with Bridge Healthcare Finance, or Bridge, a specialty
lender in the healthcare industry (see "Subsequent Event"). Upon the
establishment of this credit facility, we borrowed $15.5 million which was used
to pay off the entire balance of our existing credit facility with Wells Fargo
Foothill. Upon repayment, the existing credit facility with Wells Fargo Foothill
was terminated. Additionally, Bridge provided us approximately $0.8 million in
the form of a term loan, which we used to pay the balance of a term loan owed to
Wells Fargo Foothill.
Under the Bridge revolving credit facility, we may borrow the lesser of 85% of
the net collectible value of eligible accounts receivable plus one month
capitation receipts for the preceding month, or $20,000,000. An overadvance
subline is available not to exceed $2,000,000, so long as after giving effect to
the overadvance subline, the revolver usage does not exceed $20,000,000.
Eligible accounts receivable shall exclude those accounts older than 150 days
from invoice date and will be net of customary reserves. Dr. Berger has agreed
to personally guaranty the repayment of any monies under the overadvance
subline. Advances under the revolving loan bear interest at the base rate plus
3.25%. The base rate refers to the prime rate publicly announced by La Salle
Bank National Association, in effect from time to time. The term loan bears
interest at the annual rate of 12.50%. The revolving credit facility is
collateralized by substantially all of our accounts receivable and requires us
to meet certain financial covenants including minimum levels of EBITDA, fixed
charge coverage ratios and maximum senior debt/EBITDA ratios. The term loan is
collateralized by specific imaging equipment used by us at certain of our
locations.
As part of the Bridge Healthcare financing, our financial covenants were revised
with our creditors, including GE, US Bank and Post Advisory Group. As of July
31, 2005, we are in compliance with our financial covenants. At this time, it is
reasonably possible that no further revision of our financial covenants with our
lenders will be required, although our lenders have indicated willingness to
provide such revisions, if necessary. However, there can be no assurance our
lenders will continue to provide this type of accommodation, if required.
We also had a line of credit with an affiliate of DVI. In late November 2004, we
and Post Advisory Group, LLC, a Los Angeles-based investment advisor, issued
$4.0 million in principal amount of notes to repurchase the DVI affiliate's line
of credit facility with the residual funds utilized by us as working capital.
The new note payable has monthly interest only payments at 12% per annum until
its maturity in July 2008.
7
On December 19, 2003, we issued a $1.0 million convertible subordinate note
payable at a stated rate of 11% per annum with interest payable quarterly. The
note payable is convertible at the holder's option anytime after January 1, 2006
at $0.50 per share. As additional consideration for the financing we issued a
warrant for the purchase of 500,000 shares at an exercise price of $.50 per
share. We have allocated $0.1 million to the value of the warrants and believe
the value of the conversion feature is nominal.
During the third quarter of fiscal 2004, we renegotiated our existing notes and
capital lease obligations with our three primary lenders, General Electric
("GE"), DVI Financial Services and U.S. Bank extending terms and reducing
monthly payments on approximately $135.1 million of combined outstanding debt.
At the time of the debt restructuring, outstanding principal balances for DVI,
GE and U.S. Bank were $15.2 million, $54.3 million and $65.6 million
respectively.
DVI's restructured note payable is six payments of interest only from July to
December 2004 at 9%, 41 payments of principal and interest of $273,988, and a
final balloon payment of $7.6 million on June 1, 2008 if and only if our
subordinated bond debentures, then due, are not extended and paid in full. If
the bond debenture payment is deferred, we would make monthly payments of
$290,785 to DVI for the next 29 months. Effective November 30, 2004, Post
Advisory Group, LLC, ("Post"), acquired the DVI note payable and the
indebtedness was restructured by Post and us. The new note payable has monthly
interest only payments at 11% per annum until its maturity in June 2008. The
assignment of the note payable to Post will not result in any actual total
dollar savings to us over the term of the new obligation, but it will defer cash
outlays of approximately $1.3 million per year until its maturity.
GE's restructured note payable is six payments of interest only at 9%, or
$407,210, beginning on August 1, 2004, 40 payments of principal and interest at
$1,127,067 beginning on February 1, 2005, and a final balloon payment of $21
million due on June 1, 2008 if and only if our subordinated bond debentures,
then due, are not extended and paid in full. If the bond debenture payment is
deferred, we will continue to make monthly payments of $1,127,067 to GE for the
next 20 months.
U.S. Bank's restructured note payable is six payments of interest only at 9%, or
$491,933, beginning on August 1, 2004, 40 payments of principal and interest of
$1,055,301 beginning on February 1, 2005, and a final balloon payment of $39.7
million due on June 1, 2008 if and only if our subordinated bond debentures,
then due, are not extended and paid in full. If the bond debenture payment is
deferred, we will continue to make monthly payments of $1,055,301 to U.S. Bank
for the next 44 months.
In October 2003, we successfully consummated a "pre-packaged" Chapter 11 plan of
reorganization with the United States Bankruptcy Court, Central District of
California, in order to modify the terms of our convertible subordinated
debentures by extending the maturity to June 30, 2008, increasing the annual
interest rate from 10.0% to 11.5%, reducing the conversion price from $12.00 to
$2.50 and restricting our ability to redeem the debentures prior to July 1,
2005. The plan of reorganization did not affect any of our operations or
obligations, other than the subordinated debentures.
To assist with our financial liquidity in June 2005, Howard G. Berger, M.D., our
president, director and largest shareholder loaned us $1,370,000. Interest and
principal payments will not be made until such time as our loans to Post
Advisory Group (approximately $16.9 million) has been paid in full.
Our business strategy with regard to operations will focus on the following:
o Maximizing performance at our existing facilities;
o Focusing on profitable contracting;
o Expanding MRI and CT applications
o Optimizing operating efficiencies; and
o Expanding our networks.
Our ability to generate sufficient cash flow from operations to make payments on
our debt and other contractual obligations will depend on our future financial
performance. A range of economic, competitive, regulatory, legislative and
business factors, many of which are outside of our control, will affect our
financial performance.
Taking these factors into account, including our historical experience and our
discussions with our lenders to date, although no assurance can be given, we
believe that through implementing our strategic plans and continuing to
restructure our financial obligations, we will obtain sufficient cash to satisfy
our obligations as they become due in the next twelve months.
8
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION - Revenue consists of net patient fee for service revenue
and revenue from capitation arrangements, or capitation revenue.
Net patient service revenue is recognized at the time services are provided net
of contractual adjustments based on our evaluation of expected collections
resulting from the analysis of current and past due accounts, past collection
experience in relation to amounts billed and other relevant information.
Contractual adjustments result from the differences between the rates charged
for services performed and reimbursements by government-sponsored healthcare
programs and insurance companies for such services.
Capitation revenue is recognized as revenue during the period in which we were
obligated to provide services to plan enrollees under contracts with various
health plans. Under these contracts, we receive a per enrollee amount each month
covering all contracted services needed by the plan enrollees.
The following table summarizes net revenue for the three and nine months ended
July 31, 2004 and 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, 2004 2005 2004 2005
-------- ------------- ------------- ------------- -------------
Net patient service $ 25,521,000 $ 26,544,000 $ 78,457,000 $ 77,670,000
Capitation 8,379,000 9,634,000 25,343,000 27,808,000
------------- ------------- ------------- -------------
Net revenue $ 33,900,000 $ 36,178,000 $ 103,800,000 $ 105,478,000
============= ============= ============= =============
Accounts receivable are primarily amounts due under fee-for-service contracts
from third party payors, such as insurance companies and patients and
government-sponsored healthcare programs geographically dispersed throughout
California.
Accounts receivable as of October 31, 2004 are presented net of allowances of
approximately $58,641,000, of which $53,639,000 is included in current and
$5,002,000 is included in noncurrent. Accounts receivable as of July 31, 2005,
are presented net of allowances of approximately $55,537,000, of which
$50,800,000 is included in current and $4,737,000 is included in noncurrent.
CREDIT RISKS - Financial instruments that potentially subject us to credit risk
are primarily cash equivalents and accounts receivable. We have placed our cash
and cash equivalents with one major financial institution. At times, the cash in
the financial institution is temporarily in excess of the amount insured by the
Federal Deposit Insurance Corporation, or FDIC.
With respect to accounts receivable, we routinely assess the financial strength
of our customers and third-party payors and, based upon factors surrounding
their credit risk, establish a provision for bad debt. Net revenue by payor for
the three and nine months ended July 31, 2004 and 2005 were:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
-------------------------- -------------------------
JULY 31, 2004 2005 2004 2005
-------- ----------- ----------- --------- ------------
Capitation contracts 25 % 27 % 24 % 26 %
HMO/PPO/Managed care 21 % 22 % 21 % 22 %
Special group contract 12 % 9 % 13 % 9 %
Medicare 14 % 15 % 13 % 15 %
Blue Cross/Shield/Champus 13 % 14 % 13 % 14 %
Commercial insurance 5 % 4 % 5 % 4 %
Workers compensation 3 % 3 % 4 % 3 %
Medi-Cal 3 % 3 % 3 % 3 %
Other 4 % 3 % 4 % 4 %
Management believes that its accounts receivable credit risk exposure, beyond
allowances that have been provided, is limited.
STOCK OPTIONS - We account for our stock-based employee compensation plans under
the recognition and measurement principles of APB Opinion 25, "Accounting for
Stock Issued to Employees," and related Interpretations. No stock-based employee
compensation cost for the issuance of stock options is reflected in net income,
as all options granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of grant.
9
The following table illustrates the effect on net income and earnings per share
if we had applied the fair value recognition principles of SFAS No. 123 to
stock-based employee compensation.
FOR THE NINE MONTHS ENDED
---------------------------
JULY 31, 2004 2005
-------- ------------ ------------
Net loss as reported $(7,719,000) $(2,831,000)
Deduct: Total stock-based employee compensation
expense determined under fair value-based method (272,000) (186,000)
------------ ------------
Pro forma net loss $(7,991,000) $(3,017,000)
============ ============
Loss per share:
Basic and diluted loss per share - as reported $ (0.19) $ (0.07)
============ ============
Basic and diluted loss per share - pro forma $ (0.19) $ (0.07)
============ ============
The fair value of each option granted is estimated on the grant date using the
Black-Scholes option pricing model which takes into account as of the grant date
the exercise prices and expected life of the option, the current price of the
underlying stock and its expected volatility, expected dividends on the stock
and the risk-free interest rate for the term of the option. The following is the
average of the data used to calculate the fair value:
RISK-FREE
JULY 31, INTEREST RATE EXPECTED LIFE EXPECTED VOLATILITY EXPECTED DIVIDENDS
-------- ------------- ------------- ------------------- ------------------
2005 3.00% 5 years 49% ---
2004 3.00% 5 years 31% - 77% ---
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SHARE-BASED PAYMENT
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), "Share-Based
Payment" which was amended effective April 2005. The new rule requires that the
compensation cost relating to share-based payment transactions be recognized in
financial statements based on the fair value of the equity or liability
instruments issued. We will be required to apply Statement 123R as of the first
interim reporting period of our first fiscal year beginning on or after June 15,
2005, which is our first quarter beginning November 1, 2005. We routinely use
share-based payments arrangement as compensation for our employees. During the
nine months ended July 31, 2004 and 2005, had this rule been in effect, we would
have recorded the non-cash expense of $272,000 and $186,000, respectively.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform
with the current period presentation. These changes have no effect on net
income.
NOTE 3 - ACQUISITIONS AND DIVESTITURES
ACQUISITIONS AND OPENINGS OF IMAGING CENTERS
In January 2004, we entered into a new building lease for approximately 3,963
square feet of space in Murrietta, California, near Temecula. The center opened
in December 2004 and offers MRI, CT, PET and x-ray services. The equipment was
financed by GE.
In July 2003, we entered into a new building lease for approximately 3,533
square feet of space in Westlake, California, near Thousand Oaks. The center
opened in March 2005 and offers MRI, mammography and x-ray services.
In fiscal 2004, we opened an additional three satellite facilities servicing our
Northridge, Rancho Cucamonga and Thousand Oaks centers.
10
CLOSURE OF IMAGING CENTERS
In early fiscal 2004, we first downsized and later closed our North County
facility. The center's location was no longer productive and business could be
sent to our facility in Rancho Bernardo. The equipment was moved to other
locations and approximately $79,000 of leasehold improvements was written off.
During the nine months ended July 31, 2004, the center generated net revenue of
$49,000 and incurred a net loss of $122,000. There was no revenue since the
beginning of the second quarter of fiscal 2004.
In addition, during fiscal 2004, we closed two satellite facilities servicing
our Antelope Valley and Lancaster regions.
At various times, we may open or close small x-ray facilities acquired primarily
to service larger capitation arrangements over a specific geographic region.
Over time, patient volume from these contracts may vary, or we may end the
arrangement, resulting in the subsequent closures of these smaller satellite
facilities.
NOTE 4 - CAPITAL TRANSACTIONS
On February 17, 2004, we filed a certificate of merger with the Delaware
Secretary of State to acquire the balance of our 91%-owned subsidiary, DIS, that
we did not previously own. Pursuant to the terms of the merger, we are obligated
to pay each stockholder of DIS, other than Primedex, $0.05 per share they own.
We believe the price per share represents the value of the minority interest.
Stockholders had the right to contest the price by exercising their appraisal
rights at any time through March 15, 2004. During fiscal 2004, we paid $35,000
to acquire 648,366 shares of DIS common stock and recorded the purchases as
goodwill.
On December 19, 2003, we issued a $1.0 million convertible subordinated note
payable at a stated rate of 11% per annum with interest payable quarterly. The
note payable is convertible at the holder's option anytime after January 1, 2006
at $0.50 per share. As additional consideration for the financing, we issued a
warrant for the purchase of 500,000 shares at an exercise price of $0.50 per
share and an expiration date of December 19, 2010. We have allocated $0.1
million to the value of the warrants and believe the value of the conversion
feature is nominal.
During the nine months ended July 31, 2004, we granted 2,600,000 warrants to
seven physicians of BRMG, with the individual grants ranging from 50,000 to
1,500,000 and exercise prices ranging from $0.41 to $0.70 per share. In
addition, during the same period, we granted 950,000 warrants to one officer,
one employee and one director with the individual grants ranging from 50,000 to
450,000 and exercise prices ranging from $0.30 to $0.60 per share.
During the nine months ended July 31, 2005, we granted 700,000 warrants to two
physicians and two directors, with the individual grants ranging from 50,000 to
500,000 and exercise prices ranging from $0.32 to $0.40 per share. During the
same period, we canceled warrants to purchase 150,000 shares of stock with
exercise prices ranging from $0.49 to $0.63 per share.
During the nine months ended July 31, 2004, we issued options to purchase
150,000 shares to two employees at $0.46 per share and canceled options to
purchase 4,000 shares at $1.67 per share upon two employee terminations.
During the nine months ended July 31, 2005, we canceled options to purchase
500,000 shares at $0.40 per share that expired, and canceled options to purchase
12,500 shares at $0.46 per share upon six employee terminations.
NOTE 5 - SUBSEQUENT EVENT
Effective September 14, 2005, we established a new $20 million working capital
revolving credit facility with Bridge Healthcare Finance, or Bridge, a specialty
lender in the healthcare industry. Upon the establishment of this credit
facility, we borrowed $15.5 million which was used to pay off the entire balance
of our existing credit facility with Wells Fargo Foothill. Upon repayment, the
existing credit facility with Wells Fargo Foothill was terminated.
Additionally, Bridge provided us approximately $0.8 million in the form of a
term loan, which we used to pay the balance of a term loan owed to Wells Fargo
Foothill.
11
Under the Bridge revolving credit facility, we may borrow the lesser of 85% of
the net collectible value of eligible accounts receivable plus one month
capitation receipts for the preceding month, or $20,000,000. An overadvance
subline is available not to exceed $2,000,000, so long as after giving effect to
the overadvance subline, the revolver usage does not exceed $20,000,000.
Eligible accounts receivable shall exclude those accounts older than 150 days
from invoice date and will be net of customary reserves. Dr. Berger has agreed
to personally guaranty the repayment of any monies under the overadvance
subline.
Advances under the revolving loan bear interest at the base rate plus 3.25%. The
base rate refers to the prime rate publicly announced by La Salle Bank National
Association, in effect from time to time. The term loan bears interest at the
annual rate of 12.50%.
The revolving credit facility is collateralized by substantially all of our
accounts receivable and requires us to meet certain financial covenants
including minimum levels of EBITDA, fixed charge coverage ratios and maximum
senior debt/EBITDA ratios. The term loan is collateralized by specific imaging
equipment used by us at certain of our locations. As part of the Bridge
Healthcare financing, our financial covenants were revised with our creditors,
including GE, US Bank and Post Advisory Group.
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
OVERVIEW
We operate a group of regional networks comprised of 57 fixed-site, freestanding
outpatient diagnostic imaging facilities in California. We believe our group of
regional networks is the largest of its kind in California. We have
strategically organized our facilities into regional networks in markets, which
have both high-density and expanding populations, as well as attractive payor
diversity.
All of our facilities employ state-of-the-art equipment and technology in
modern, patient-friendly settings. Many of our facilities within a particular
region are interconnected and integrated through our advanced information
technology system. Thirty-four of our facilities are multi-modality sites,
offering various combinations of MRI, CT, PET/CT, nuclear medicine, ultrasound,
X-ray and fluoroscopy services. Twenty-three of our facilities are
single-modality sites, offering either X-ray or MRI services. Consistent with
our regional network strategy, we locate our single-modality sites near
multi-modality sites to help accommodate overflow in targeted demographic areas.
We derive substantially all of our revenue, directly or indirectly, from fees
charged for the diagnostic imaging services performed at our facilities. Over
the past years, we have increased net revenue primarily through acquisitions,
expansions of existing facilities, upgrades in equipment, development of new
facilities, marketing and contracting, and improvements in net reimbursement.
The fees charged for diagnostic imaging services performed at our facilities are
paid by a diverse mix of payors, as illustrated for the nine months ended July
31, 2005 by the following table:
PERCENTAGE
OF NET
PAYOR TYPE REVENUE
---------- -------
Insurance(1) 40%
Managed Care Capitated Payors 26
Medicare/Medi-Cal 18
Other(2) 11
Workers Compensation/Personal Injury 5
- ----------
(1) Includes Blue Cross/Blue Shield, which represented 14% of our net revenue
for the nine months ended July 31, 2005.
(2) Includes co-payments, direct patient payments and payments through contracts
with physician groups and other non-insurance company payors.
Our eligibility to provide service in response to a referral often depends on
the existence of a contractual arrangement between the radiologists providing
the professional medical services, or us, and the referred patient's insurance
carrier or managed care organization. These contracts typically describe the
negotiated fees to be paid by each payor for the diagnostic imaging services we
provide. With the exception of Blue Cross/Blue Shield and government payors, no
single payor accounted for more than 5% of our net revenue for the nine months
ended July 31, 2005. Under our capitation agreements, we receive from the payor
a pre-determined amount per member, per month. If we do not successfully manage
the utilization of our services under these agreements, we could incur
unanticipated costs not offset by additional revenue, which would reduce our
operating margins.
The principal components of our fixed operating expenses, excluding
depreciation, include professional fees paid to radiologists, except for those
radiologists who are paid based on a percentage of revenue, compensation paid to
technologists and other facility employees, and expenses related to equipment
rental and purchases, real estate leases and insurance, including errors and
omissions, malpractice, general liability, workers' compensation and employee
medical. The principal components of our variable operating expenses include
expenses related to equipment maintenance, medical supplies and certain outside
service expenses paid per exam or per use during the period. Because a majority
of our expenses are fixed, increased revenue as a result of higher scan volumes
per system can significantly improve our margins, while lower scan volumes can
result in significantly lower margins.
13
BRMG strives to maintain qualified radiologists and technologists while
minimizing turnover and salary increases and avoiding the use of outside
staffing agencies, which are considerably more expensive and less efficient. In
recent years, there has been a shortage of qualified radiologists and
technologists in some of the regional markets we serve. As turnover occurs,
competition in recruiting radiologists and technologists may make it difficult
for our contracted radiology practices to maintain adequate levels of
radiologists and technologists without the use of outside staffing agencies. At
times, this has resulted in increased costs for us.
OUR RELATIONSHIP WITH BRMG
Howard G. Berger, M.D. is our President and Chief Executive, a member of our
Board of Directors, and owns approximately 30% of Primedex's outstanding common
stock. Dr. Berger also owns, indirectly, 99% of the equity interests in BRMG.
BRMG provides all of the professional medical services at 42 of our facilities
under a management agreement with us, and contracts with various other
independent physicians and physician groups to provide all of the professional
medical services at most of our other facilities. We obtain professional medical
services from BRMG, rather than providing such services directly or through
subsidiaries, in order to comply with California's prohibition against the
corporate practice of medicine. However, as a result of our close relationship
with Dr. Berger and BRMG, we believe that we are able to better ensure that
professional medical services are provided at our facilities in a manner more
consistent with our needs and expectations and those of our referring
physicians, patients and payors than if we obtained these services from
unaffiliated practice groups.
Under our management agreement with BRMG, which expires on January 1, 2014, BRMG
pays us, as compensation for the use of our facilities and equipment and for our
services, a percentage of the gross amounts collected for the professional
services it renders. The percentage, which was 79% at July 31, 2005, is adjusted
annually, if necessary, to ensure that the parties receive fair value for the
services they render. In operation and historically, the annual revenue of BRMG
from all sources closely approximates their expenses, including Dr. Berger's
compensation, fees payable to us, and amounts payable to third parties. For
administrative convenience and in order to avoid inconveniencing and confusing
our payors, a single bill is prepared for both the professional medical services
provided by the radiologists and our non-medical, or technical, services,
generating a receivable for BRMG. BRMG finances these receivables under a
working capital facility with Wells Fargo Foothill and regularly advances to us
the funds that it draws under this working capital facility, which we use for
our own working capital purposes. We repay or offset these advances with
periodic fees from BRMG to us under the management agreement. We guarantee
BRMG's obligations under this working capital facility.
As a result of our contractual and operational relationship with BRMG and Dr.
Berger, we are required to include BRMG as a consolidated entity in our
consolidated financial statements.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
certain items in the statement of operations bears to net revenue.
14
NINE MONTHS ENDED JULY 31,
--------------------------
2004 2005
------ ------
Net revenue 100.0% 100.0%
Operating expenses:
Operating expenses 76.5 75.7
Depreciation and amortization 12.8 12.2
Provision for bad debts 3.8 2.6
Loss on disposal of equipment, net -- 0.7
------ ------
Total operating expense 93.1 91.2
Income from operations 6.9 8.8
Other expense (income):
Interest expense 12.7 12.1
Other income (0.1) (0.6)
Other expense 1.5 --
------ ------
Total other expense 14.1 11.5
Loss before minority interest (7.2) (2.7)
Minority interest in earnings of subsidiaries (0.2) --
------ ------
Net loss (7.4) (2.7)
====== ======
NINE MONTHS ENDED JULY 31, 2005 COMPARED TO THE NINE MONTHS ENDED JULY 31, 2004
During the last nine months, we continued our efforts to enhance our operations
and expand our network, while improving our financial position and cash flows.
Our results for the nine months ended July 31, 2004 were affected by the costs
associated with refinancing our existing debt and our attempt to solidify
financing through a bond offering. As a result of these factors and the other
matters discussed below, we experienced a increase in income from operations of
$2.2 million and reduced our net loss by $4.9 million for the nine months ended
July 31, 2005 when compared to the same period last year.
During fiscal 2004 and the first nine months of fiscal 2005, we made significant
progress in solidifying our financial condition. We restructured the majority of
our existing notes and capital lease obligations consolidating balances,
extending terms and improving future net cash flows for debt service, and we
restructured our working capital line with a new lender, Wells Fargo Foothill.
Effective November 30, 2004, we and Post Advisory Group, LLC, ("Post"), a Los
Angeles-based investment advisor, issued $4.0 million in principal amount of
notes to repurchase the DVI affiliate's line of credit facility with the
residual funds utilized as working capital. The new note payable has monthly
interest only payments at 12% per annum until its maturity in July 2008. In
addition, Post acquired $15.2 million of our notes payable from an affiliate of
DVI and the indebtedness was restructured by Post and us. The new note payable
has monthly interest only payments at 11% per annum until its maturity in June
2008. The assignment of the note payable to Post will not result in any actual
total dollar savings to us over the term of the new obligation, but it will
defer cash flow outlays of approximately $1.3 million per year until maturity.
Net cash used by financing activities decreased from $11.0 million for the first
nine months of fiscal 2004 to $4.1 million for the same period in fiscal 2005.
At the same time, however, our working capital deficit increased from $32.2
million as of October 31, 2004 to $33.4 million as of July 31, 2005 and net cash
provided by operating activities decreased for the nine months ended July 31,
2005 when compared to the same period last year.
NET REVENUE
Net revenue for the nine months ended July 31, 2005 was $105.5 million compared
to $103.8 million for the same period in fiscal 2004, an increase of
approximately $1.7 million. The increase was net of $49,000 in net revenue
attributable to North County which was closed in fiscal 2004.
15
We have continued to improve our yield from capitation contracts as a result of
contractual and negotiated increases in reimbursement coupled with improved
collections of co-payments from the individual patients. We also added a new
capitation agreement in Modesto, California for approximately 25,000 lives
beginning in May 2005, and renewed a previously terminated contract in Temecula,
California for approximately 28,000 lives beginning in July 2005. Special group
contract and workers compensation business continued to decline due to changes
in the workers' compensation laws in California which made it more difficult for
litigated claimants.
During the nine months ended July 31, 2005, the largest net revenue increases
were at the Palm Springs (Desert Advanced), Orange Imaging, and two Tarzana
facilities with combined increases of approximately $3.4 million when comparing
results with the same period last year. The Orange facilities' continued growth
is due to a variety of factors including their physical locations, improvements
in contracted reimbursement and increases in patient volume and throughput. The
continued improvements at the Palm Springs and Palm Desert facilities is due to
increased marketing, increased capitation reimbursement and the maturity of
these newer facilities opened in late 2001. The improvements at the Tarzana
facilities were primarily due to increases in MRI and PET/CT revenue due to the
hiring of one new physician and contracting the services of one additional
physician who specialize in MRI and PET/CT, respectively.
The largest decreases in net revenue were at the Lancaster and Antelope Valley
facilities with combined decreases of approximately $1.4 million. The Lancaster
and Antelope Valley net revenue decreases were due to the termination of a
capitation contract in March 2004 when we were unable to secure a sufficient
price increase to warrant its renewal.
OPERATING EXPENSES
Operating expenses for the nine months ended July 31, 2005 decreased
approximately $496,000 from $96.7 million in the nine months ended July 31, 2004
to $96.2 million in the same period this year. The decrease included $141,000 of
net operating expenses related to North County that closed in fiscal 2004.
The following table sets forth our operating expenses for the nine months ended
July 31, 2004 and 2005 (dollars in thousands):
Nine Months Ended July 31,
--------------------------
2004 2005
--------- ---------
Salaries and professional reading fees $ 48,639 $ 49,122
Building and equipment rental 5,849 5,837
General administrative expenses 24,913 24,833
--------- ---------
Total operating expenses 79,401 79,792
Depreciation and amortization 13,295 12,905
Provision for bad debt 3,984 2,789
Loss on disposal of equipment, net -- 698
o SALARIES AND PROFESSIONAL READING FEES
Salaries and professional reading fees increased $483,000 for the nine
months ended July 31, 2005 when compared to the same period last year.
For the nine months ended July 31, 2004 and 2005, salaries were
$31,266,000 and $31,329,000, respectively, and professional reading
fees were $17,373,000 and $17,793,000, respectively. The majority of
the increase is from professional reading fees and is primarily due to
the higher costs associated with recruiting and retaining key personnel
and solidifying Beverly Hills physician staff due to the disruption in
October 2003. During the nine months ended July 31, 2004, our Beverly
Hills facilities had professional reading fees of $2,049,000 compared
to $2,791,000 for the same period this year. Since January 2004 and
throughout the fiscal year, BRMG rehired seven former key radiologists
in the area for the Beverly Hills facilities to solidify its staffing
and related referral base.
o BUILDING AND EQUIPMENT RENTAL
Building and equipment rental expenses decreased $12,000 for the nine
months ended July 31, 2005 when compared to the same period last year.
The decrease is primarily due to the buyout of an equipment operating
lease in Modesto in April 2004, offset by the addition of building
rental expense for the new centers in Murietta and Westlake coupled
with annual increases in base rentals from existing leased facilities.
16
o GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business
tax and license, outside services, utilities, marketing, travel and
other expenses. Many of these expenses are variable in nature. These
expenses decreased $80,000 for the nine months ended July 31, 2005 when
compared to the same period last year. The decrease is primarily due to
the reduction in the Company's medical equipment maintenance agreement
from 3.74% of net revenue in fiscal 2004 to 3.50% of net revenue in
fiscal 2005, and the decrease in expenditures for insurance upon
becoming self-insured for workers compensation and employee medical
coverage. These decreases were offset by increases in the expenditures
for billing and collection, medical supplies, outside services and
utilities during the same periods.
o DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased by $390,000 for the nine months
ended July 31, 2005 when compared to the same period last year. The
decrease includes $71,000 of depreciation expense related to North
County that closed in fiscal 2004. Additions of new property and
equipment and the related depreciation was offset by historical
property and equipment fully depreciating over the same period.
o PROVISION FOR BAD DEBT
The $1.2 million decrease in provision for bad debt for the nine months
ended July 31, 2005 when compared to the same period last year was
primarily a result of decreased bad debt write-offs, increased
capitation revenue, decreased special group contract revenue, the
improvement in billing and collections with the conversion to a single
internal system and no significant payor dissolutions in the last
twelve months.
o LOSS ON DISPOSAL OF EQUIPMENT, NET
The $698,000 net loss on the disposal of equipment for the nine months
ended July 31, 2005 was primarily due to the trade-in of an MRI at one
of our facilities and replacing the equipment with an enhanced machine
which will improve throughput and meet patient volume demands.
INTEREST EXPENSE
Interest expense for the nine months ended July 31, 2005 decreased $359,000 when
compared to the same period last year. During fiscal 2004, we renegotiated our
existing notes and capital lease obligations with our three primary lenders,
General Electric ("GE"), DVI Financial Services and U.S. Bank extending terms
and reducing monthly payments on approximately $135.1 million of combined
outstanding debt. During the restructuring, interest accrued on a large portion
of our outstanding unpaid principal balances until the renegotiation finalized
in late July 2004.
OTHER INCOME
During the nine months ended July 31, 2004 and 2005, we earned other income of
$141,000 and $688,000, respectively, principally comprised of sublease income,
record copy income, write-offs of certain liabilities and deferred rent income.
During the nine months ended July 31, 2004, we recognized deferred rental income
of $67,000, record copy income of $33,000, gain on bond extinguishments of
$5,000, gains on disposals of $26,000, and miscellaneous income of $10,000. In
the nine months ended July 31, 2005, we recognized gains from write-offs of
liabilities previously expensed in fiscal 2004 for approximately $62,000, gains
from the write-off of certain notes payable past statute for $515,000, deferred
rental income of $67,000, and record copy income of $44,000.
OTHER EXPENSE
During the nine months ended July 31, 2004 and 2005, we incurred other expense
of $1,587,000 and $25,000, respectively, principally comprised of write-offs of
miscellaneous receivables and other assets, and costs related to bond offerings
and debt restructures. During the nine months ended July 31, 2004, we recognized
losses of $1,444,000 related to the Company's attempt in solidifying financing
with a bond offering and debt refinancing, $64,000 in charges incurred upon the
conversion of an operating lease into a capital lease, and $79,000 for the
abandonment of leasehold improvements at North County. During the nine months
ended July 31, 2005, we recognized losses on the write-off of other assets of
$25,000.
17
MINORITY INTEREST IN EARNINGS OF SUBSIDIARIES
Minority interest in earnings of subsidiaries represents the minority investors'
25% share of the income from the Burbank Advanced Imaging Center LLC and 25%
share of the Rancho Bernardo Advanced LLC for the period. Both center's residual
interests were purchased by us in September and July 2004, respectively. We now
own 100% of all our locations and our minority interest liabilities have been
eliminated. Minority interest expense for the nine months ended July 31, 2004,
previous to the buyouts, was $246,000.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
certain items in the statement of operations bears to net revenue.
THREE MONTHS ENDED JULY 31,
---------------------------
2004 2005
------ ------
Net revenue 100.0% 100.0%
Operating expenses:
Operating expenses 79.8 74.1
Depreciation and amortization 13.1 11.7
Provision for bad debts 3.9 2.6
Loss on disposal of equipment, net -- --
------ ------
Total operating expense 96.8 88.4
Income from operations 3.2 11.6
Other expense (income):
Interest expense 13.8 11.8
Other income (0.2) (0.1)
Other expense 2.2 --
------ ------
Total other expense 15.8 11.7
Loss before minority interest (12.6) (0.1)
Minority interest in earnings of subsidiaries (0.7) --
------ ------
Net loss (13.3) (0.1)
====== ======
THREE MONTHS ENDED JULY 31, 2005 COMPARED TO THE THREE MONTHS ENDED JULY 31,
2004
NET REVENUE
Net revenue for the three months ended July 31, 2005 was $36.2 million compared
to $33.9 million for the same period in fiscal 2004, an increase of
approximately $2.3 million.
We have continued to improve our yield from capitation contracts as a result of
contractual and negotiated increases in reimbursement coupled with improved
collections of co-payments from the individual patients. We also added a new
capitation agreement in Modesto, California for approximately 25,000 lives
beginning in May 2005, and renewed a previously terminated contract in Temecula,
California for approximately 28,000 lives beginning in July 2005. Special group
contract and workers compensation business continued to decline due to changes
in the workers' compensation laws in California which made it more difficult for
litigated claimants.
18
During the three months ended July 31, 2005, the largest net revenue increases
were at the Long Beach (Los Coyotes), Thousand Oaks (MDI), Modesto, Palm Springs
(Desert Advanced), Orange Imaging, and two Tarzana facilities with combined
increases of approximately $2.3 million when comparing results with the same
period last year. Thousand Oaks' net revenue improvement was due primarily to
the opening of a new center in Westlake, California in May 2005 offering MRI,
ultrasound and mammography services. The Modesto net revenue improvement was due
to a new capitation arrangement for approximately 25,000 lives beginning in May
2005. The Long Beach and Orange facilities' continued growth is due to a variety
of factors including their physical locations, improvements in contracted
reimbursement and increases in patient volume and throughput. The continued
improvements at the Palm Springs and Palm Desert facilities is due to increased
marketing, increased capitation reimbursement and the maturity of these newer
facilities opened in late 2001. The improvements at the Tarzana facilities were
primarily due to increases in MRI and PET/CT revenue due to the hiring of one
new physician and contracting the services of one additional physician who
specializes in MRI and PET/CT, respectively.
The largest decreases in net revenue were at the Woodward Park and Tower
facilities with combined decreases of approximately $0.6 million. The net
revenue decreases at both centers was due to increased competition in their
respective areas.
OPERATING EXPENSES
Operating expenses for the three months ended July 31, 2005 decreased
approximately $841,000 from $32.8 million in the third quarter of fiscal 2004 to
$32.0 million in the same quarter this year.
The following table sets forth our operating expenses for the three months ended
July 31, 2004 and 2005 (dollars in thousands):
Three Months Ended July 31,
---------------------------
2004 2005
--------- ---------
Salaries and professional reading fees $ 16,689 $ 16,344
Building and equipment rental 1,923 1,949
General administrative expenses 8,427 8,497
--------- ---------
Total operating expenses 27,039 26,790
Depreciation and amortization 4,453 4,243
Provision for bad debt 1,328 946
Loss on disposal of equipment, net -- --
o SALARIES AND PROFESSIONAL READING FEES
Salaries and professional reading fees decreased $345,000 for the three
months ended July 31, 2005 when compared to the same period last year.
For the three months ended July 31, 2004 and 2005, salaries were
$10,313,000 and $10,410,000, respectively, and professional reading
fees were $6,376,000 and $5,934,000, respectively. In the third quarter
of fiscal 2004, we incurred additional costs for new physicians,
including incentives and recruitment expenditures, and recorded bonuses
under contracted percentage arrangements for certain facilities.
o BUILDING AND EQUIPMENT RENTAL
Building and equipment rental expenses increased $26,000 for the three
months ended July 31, 2005 when compared to the same period last year.
The increase is primarily due to new centers in Murietta and Westlake
coupled with annual increases in base rentals from existing leased
facilities.
19
o GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include billing fees, medical
supplies, office supplies, repairs and maintenance, insurance, business
tax and license, outside services, utilities, marketing, travel and
other expenses. Many of these expenses are variable in nature. These
expenses increased $70,000 for the three months ended July 31, 2005
when compared to the same period last year. The increase is primarily
due to increases in expenditures for medical supplies, utilities and
outside services primarily due to higher net revenue. The increase was
offset by a reduction in costs under our medical equipment maintenance
agreement which decreased from 3.74% to 3.50% of net revenue effective
November 1, 2004, and the decrease in expenditures for insurance upon
becoming self-insured for workers compensation and employee medical
coverage.
o DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased by $210,000 for the three
months ended July 31, 2005 when compared to the same period last year.
Additions of new property and equipment and the related depreciation
was offset by historical property and equipment fully depreciating over
the same period.
o PROVISION FOR BAD DEBT
The $382,000 decrease in provision for bad debt for the three months
ended July 31, 2005 when compared to the same period last year was
primarily a result of decreased bad debt write-offs, increases in
capitation revenue, decreased special group contract revenue, the
improvement in billing and collections with the conversion to a single
internal computer system and no significant payor dissolutions in the
last twelve months.
INTEREST EXPENSE
Interest expense for the three months ended July 31, 2005 decreased $414,000
when compared to the same period last year. During the third quarter of fiscal
2004, we renegotiated our existing notes and capital lease obligations with our
three primary lenders, General Electric ("GE"), DVI Financial Services and U.S.
Bank extending terms and reducing monthly payments on approximately $135.1
million of combined outstanding debt. During the restructuring, interest accrued
on a large portion of our outstanding unpaid principal balances until the
renegotiation finalized in late July 2004.
OTHER INCOME
For the three months ended July 31, 2004 and 2005, we earned other income of
$70,000 and $42,000, respectively, principally comprised of sublease income,
record copy income, write-offs of certain liabilities and deferred rent income.
In the three months ended July 31, 2004, we recognized deferred rental income of
$23,000, a gain on early extinguishments of bonds of $5,000, a gain on disposal
of $26,000, and record copy income of $16,000. In the three months ended July
31, 2005, we recognized deferred rental income of $22,000 and record copy income
of $20,000.
OTHER EXPENSE
In the three months ended July 31, 2004 and 2005, we incurred other expense of
$741,000 and $-0-, respectively, principally comprised of costs related to bond
offerings and debt restructures. During the three months ended July 31, 2004, we
recognized losses of $662,000 related to our attempt in solidifying financing
with a bond offering and debt refinancing, and $79,000 due to the write-off of
leasehold improvements at North County which was closed.
MINORITY INTEREST IN EARNINGS OF SUBSIDIARIES
Minority interest in earnings of subsidiaries represents the minority investors'
25% share of the income from the Burbank Advanced Imaging Center LLC and 25%
share of the Rancho Bernardo Advanced LLC for the period. Both center's residual
interests were purchased by us in September and July 2004, respectively. We now
own 100% of all our locations and our minority interest liabilities have been
eliminated. Minority interest expense for the three months ended July 31, 2004,
previous to the buyouts, was $234,000.
20
LIQUIDITY AND CAPITAL RESOURCES
We had a working capital deficit of $33.4 million at July 31, 2005 compared to a
$32.2 million deficit at October 31, 2004, and had losses from operations of
$37,000 and $4.5 million during the three months ended July 31, 2005 and 2004,
respectively, and had losses from operations of $2.8 million and $7.7 million
during the nine months ended July 31, 2005 and 2004, respectively. We also had a
stockholders' deficit of $70.3 million at July 31, 2005 compared to a $67.6
million deficit at October 31, 2004.
We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations. In addition to operations, we
require significant amounts of capital for the initial start-up and development
expense of new diagnostic imaging facilities, the acquisition of additional
facilities and new diagnostic imaging equipment, and to service our existing
debt and contractual obligations. Because our cash flows from operations are
insufficient to fund all of these capital requirements, we depend on the
availability of financing under credit arrangements with third parties.
Historically, our principal sources of liquidity have been funds available for
borrowing under our existing line of credit, now with Wells Fargo Foothill. Even
though the line of credit matures in 2008, we classify the line of credit as a
current liability primarily because it is collateralized by accounts receivable
and the eligible borrowing base is classified as a current asset. We finance the
acquisition of equipment mainly through capital and operating leases. As of July
31, 2005 and October 31, 2004, our line of credit liabilities were $11.6 million
and $14.0 million, respectively.
During the last twelve months, we took the actions described below to continue
to fund our obligations. In addition, some of our plans to provide the necessary
working capital in the future are summarized below.
BRMG and Wells Fargo Foothill are parties to a credit facility under which BRMG
may borrow the lesser of 85% of the net collectible value of eligible accounts
receivable plus one month of average capitation receipts for the prior six
months, two times the trailing month cash collections, or $20,000,000. Eligible
accounts receivable shall exclude those accounts older than 150 days from
invoice date and will be net of customary reserves. In addition, Wells Fargo
Foothill set up a term loan where they can advance up to the lesser of
$3,000,000 or 80% of the liquidation value of the equipment value servicing the
loan. Under this term loan, we borrowed $880,000 in February 2005 to acquire
medical equipment. The five-year term loan had interest only payments through
February 28, 2005 with the first quarterly principal payments due on April 1,
2005. Access to additional funds under the term loan expired soon after the
February 2005 draw.
Under the $20,000,000 revolving loan, an overadvance subline will be available
not to exceed $2,000,000, or one month of the average capitation receipts for
the prior six months, until June 30, 2005. From July 1 to September 30, 2005,
the overadvance subline will be available not to exceed $1,500,000, or one month
of the average capitation receipts for the prior six months. Beginning October
1, 2005, the maximum overadvance cannot exceed the lesser of $1,000,000 or one
month of the average capitation receipts for the prior six months. Also under
the revolving loan, we are entitled to request that Wells Fargo Foothill issue
guarantees of payment with respect to letters of credit issued by an issuing
bank in an aggregate amount not to exceed $5,000,000 at any one time
outstanding. At July 31, 2005, the prime rate was 6.25% and we had $4.5 million
of available borrowing under the Wells Fargo Foothill revolving loan.
Advances outstanding under the revolving loan bear interest at the base rate
plus 1.5%, or the LIBOR rate plus 3.0%. Advances under the overadvance subline
and term loan bear interest at the base rate plus 4.75%. Letter of credit fees
bear interest of 3.0% per annum times the undrawn amount of all outstanding
lines of credit. The base rate refers to the rate of interest announced within
Wells Fargo Bank at its principal office in San Francisco as it prime rate. The
line is collateralized by substantially all of our accounts receivable and
requires us to meet certain financial covenants including minimum levels of
EBITDA, fixed charge coverage ratios and maximum senior debt/EBITDA ratios as
well as limitations on annual capital expenditures.
Effective September 14, 2005, we established a new $20 million working capital
revolving credit facility with Bridge Healthcare Finance, or Bridge, a specialty
lender in the healthcare industry (see "Subsequent Event"). Upon the
establishment of this credit facility, we borrowed $15.5 million which was used
to pay off the entire balance of our existing credit facility with Wells Fargo
21
Foothill. Upon repayment, the existing credit facility with Wells Fargo Foothill
was terminated. Additionally, Bridge provided us approximately $0.8 million in
the form of a term loan, which we used to pay the balance of a term loan owed to
Wells Fargo Foothill.
Under the Bridge revolving credit facility, we may borrow the lesser of 85% of
the net collectible value of eligible accounts receivable plus one month
capitation receipts for the preceding month, or $20,000,000. An overadvance
subline is available not to exceed $2,000,000, so long as after giving effect to
the overadvance subline, the revolver usage does not exceed $20,000,000.
Eligible accounts receivable shall exclude those accounts older than 150 days
from invoice date and will be net of customary reserves. Dr. Berger has agreed
to personally guaranty the repayment of any monies under the overadvance
subline. Advances under the revolving loan bear interest at the base rate plus
3.25%. The base rate refers to the prime rate publicly announced by La Salle
Bank National Association, in effect from time to time. The term loan bears
interest at the annual rate of 12.50%. The revolving credit facility is
collateralized by substantially all of our accounts receivable and requires us
to meet certain financial covenants including minimum levels of EBITDA, fixed
charge coverage ratios and maximum senior debt/EBITDA ratios. The term loan is
collateralized by specific imaging equipment used by us at certain of our
locations.
As part of the Bridge Healthcare financing, our financial covenants were revised
with our creditors, including GE, US Bank and Post Advisory Group. As of July
31, 2005, we are in compliance with our financial covenants. At this time, it is
reasonably possible that no further revision of our financial covenants with our
lenders will be required, although our lenders have indicated willingness to
provide such revisions, if necessary. However, there can be no assurance our
lenders will continue to provide this type of accommodation, if required.
We also had a line of credit with an affiliate of DVI. In late November 2004, we
and Post Advisory Group, LLC, a Los Angeles-based investment advisor, issued
$4.0 million in principal amount of notes to repurchase the DVI affiliate's line
of credit facility with the residual funds utilized by us as working capital.
The new note payable has monthly interest only payments at 12% per annum until
its maturity in July 2008.
On December 19, 2003, we issued a $1.0 million convertible subordinate note
payable at a stated rate of 11% per annum with interest payable quarterly. The
note payable is convertible at the holder's option anytime after January 1, 2006
at $0.50 per share. As additional consideration for the financing we issued a
warrant for the purchase of 500,000 shares at an exercise price of $.50 per
share. We have allocated $0.1 million to the value of the warrants and believe
the value of the conversion feature is nominal.
During the third quarter of fiscal 2004, we renegotiated our existing notes and
capital lease obligations with our three primary lenders, General Electric
("GE"), DVI Financial Services and U.S. Bank extending terms and reducing
monthly payments on approximately $135.1 million of combined outstanding debt.
At the time of the debt restructuring, outstanding principal balances for DVI,
GE and U.S. Bank were $15.2 million, $54.3 million and $65.6 million
respectively.
DVI's restructured note payable is six payments of interest only from July to
December 2004 at 9%, 41 payments of principal and interest of $273,988, and a
final balloon payment of $7.6 million on June 1, 2008 if and only if our
subordinated bond debentures, then due, are not extended and paid in full. If
the bond debenture payment is deferred, we would make monthly payments of
$290,785 to DVI for the next 29 months. Effective November 30, 2004, Post
Advisory Group, LLC, ("Post"), acquired the DVI note payable and the
indebtedness was restructured by Post and us. The new note payable has monthly
interest only payments at 11% per annum until its maturity in June 2008. The
assignment of the note payable to Post will not result in any actual total
dollar savings to us over the term of the new obligation, but it will defer cash
outlays of approximately $1.3 million per year until its maturity.
GE's restructured note payable is six payments of interest only at 9%, or
$407,210, beginning on August 1, 2004, 40 payments of principal and interest at
$1,127,067 beginning on February 1, 2005, and a final balloon payment of $21
million due on June 1, 2008 if and only if our subordinated bond debentures,
then due, are not extended and paid in full. If the bond debenture payment is
deferred, we will continue to make monthly payments of $1,127,067 to GE for the
next 20 months.
U.S. Bank's restructured note payable is six payments of interest only at 9%, or
$491,933, beginning on August 1, 2004, 40 payments of principal and interest of
$1,055,301 beginning on February 1, 2005, and a final balloon payment of $39.7
million due on June 1, 2008 if and only if our subordinated bond debentures,
then due, are not extended and paid in full. If the bond debenture payment is
deferred, we will continue to make monthly payments of $1,055,301 to U.S. Bank
for the next 44 months.
22
In October 2003, we successfully consummated a "pre-packaged" Chapter 11 plan of
reorganization with the United States Bankruptcy Court, Central District of
California, in order to modify the terms of our convertible subordinated
debentures by extending the maturity to June 30, 2008, increasing the annual
interest rate from 10.0% to 11.5%, reducing the conversion price from $12.00 to
$2.50 and restricting our ability to redeem the debentures prior to July 1,
2005. The plan of reorganization did not affect any of our operations or
obligations, other than the subordinated debentures.
To assist with our financial liquidity in June 2005, Howard G. Berger, M.D., our
president, director and largest shareholder loaned us $1,370,000. Interest and
principal payments will not be made until such time as our loans to Post
Advisory Group (approximately $16.9 million) has been paid in full.
Our business strategy with regard to operations will focus on the following:
o Maximizing performance at our existing facilities;
o Focusing on profitable contracting;
o Expanding MRI and CT applications
o Optimizing operating efficiencies; and
o Expanding our networks.
Our ability to generate sufficient cash flow from operations to make payments on
our debt and other contractual obligations will depend on our future financial
performance. A range of economic, competitive, regulatory, legislative and
business factors, many of which are outside of our control, will affect our
financial performance.
We are subject to certain financial covenants with our primary lenders. Our
lenders revised portions of the covenants to permit us to avoid not achieving
certain minimums and being in default of our loans since April 30, 2005. At this
time our preliminary analysis indicates it is reasonably possible that no
further revision to our financial covenants with our lenders will be required,
although our lenders have indicated willingness to provide such revisions, if
necessary. However, there can be no assurance our lenders will continue to
provide this type of accommodation, if required.
Taking these factors into account, including our historical experience and our
discussions with our lenders to date, although no assurance can be given, we
believe that through implementing our strategic plans and continuing to
restructure our financial obligations, we will obtain sufficient cash to satisfy
our obligations as they become due in the next twelve months.
SOURCES AND USES OF CASH
Cash increased for the nine months ended July 31, 2005 and 2004 by $1,000 and
$242,000, respectively.
Cash provided by operating activities for the nine months ended July 31, 2005
was $6.8 million compared to $13.3 million for the same period in 2004. The
primary reason for the decrease in cash was due to interest expense of
approximately $5.8 million which was accrued, but unpaid, during the first nine
months of fiscal 2004 while renegotiating a portion of our existing notes and
capital lease obligations. In addition, during fiscal 2005, we were required to
make a deposit of approximately $1.2 million when we became self -insured for
workers compensation insurance.
Cash used for investing activities for the nine months ended July 31, 2005 was
$2.8 million compared to $2.1 million for the same period in 2004. For the nine
months ended July 31, 2005 and 2004, we purchased property and equipment for
approximately $2.8 million and $2.1 million, respectively. During the nine
months ended July 31, 2005, we received proceeds from the sale of equipment of
$65,000. During the nine months ended July 31, 2004, we purchased additional DIS
common stock for $35,000.
Cash used for financing activities for the nine months ended July 31, 2005 was
$4.1 million compared to $11.0 million for the same period in 2004. For the nine
months ended July 31, 2005 and 2004, we made principal payments on capital
leases and notes payable of $9.6 million and $12.0 million, respectively, and
received proceeds from borrowings on notes payable of approximately $5.3 million
and $0.9 million, respectively. During the nine months ended July 31, 2005, we
increased cash disbursements in transit by $1.2 million, made payments on lines
of credit of $2.4 million, and received proceeds from borrowings from related
parties of $1.4 million. During the nine months ended July 31, 2004, we
decreased cash disbursements in transit by $0.8 million, received proceeds from
the issuance of a convertible subordinated note payable of $1.0 million, and
purchased bond debentures for $0.1 million.
23
CONTRACTUAL COMMITMENTS
Our future obligations for notes payable, equipment under capital leases,
lines of credit, subordinated debentures, equipment and building operating
leases and purchase and other contractual obligations for the next five
years and thereafter include (dollars in thousands):
FOR THE TWELVE MONTHS ENDED JULY 31,
THERE-
2006 2007 2008 2009 2010 AFTER TOTAL
-------- -------- -------- -------- -------- -------- --------
Notes payable*(4) $ 14,174 $ 13,060 $ 61,622 $ -- -- -- $ 88,856
Capital leases* 17,681 17,340 41,494 1,385 541 -- 78,441
Lines of credit(4) 11,613 -- -- -- -- -- 11,613
Subordinated debentures -- -- 16,147 -- -- -- 16,147
Operating leases 6,743 5,571 4,360 3,596 3,262 11,070 34,602
Purchase obligations(1) 2,500 625 -- -- -- -- 3,125
Tower settlement 324 -- -- -- -- -- 324
Other obligations(2) 73 -- -- -- -- -- 73
-------- -------- -------- -------- -------- -------- --------
TOTAL{3} $ 53,108 $ 36,596 $123,623 $ 4,981 $ 3,803 $ 11,070 $233,181
- -----------------
* Includes interest.
1 Includes a three-year obligation to purchase imaging film from Fuji. We must
purchase an aggregate of $7.5 million of film at a rate of approximately
$2.5 million per year over the term of the agreement.
2 Other short-term obligations related to buyouts of the limited liability
company minority interests in Rancho Bernardo and Burbank and other assets.
3 Does not include our obligation under our maintenance agreement with GE
Medical Systems described below.
4 Does not include the effect of the new credit facility and term loan with
Bridge Healthcare Finance (see "Subsequent Event"). The subsequent
borrowings and payments under the respective loans reflect post July 31,
2005 transactions and operating cash flows. The effect of the restructured
term loan is immaterial.
We are parties to an agreement with GE Medical Systems for the maintenance and
repair of the majority of our medical equipment for a fee based upon a
percentage of net revenues, subject to minimum aggregate net revenue
requirements. The agreement expires on October 31, 2009 and is retroactive to
November 1, 2004. The current annual service fee is the greater of 3.50% of our
net revenue (less provisions for bad debt) or approximately $5.0 million. The
aggregate minimum net revenue ranges from $142.0 million to $150.0 million and
the annual service fee percentage ranges from 3.50% to 3.62% during the term of
the agreement. For fiscal 2004, the monthly service fees were 3.74% of net
revenue with minimum net revenue of $125.0 million. We believe this framework of
basing service costs on usage is an effective and unique method for controlling
our overall costs on a facility-by-facility basis.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements reflect, among other things, management's current
expectations and anticipated results of operations, all of which are subject to
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements, or industry results, to differ
materially from those expressed or implied by such forward-looking statements.
Therefore, any statements contained herein that are not statements of historical
fact may be forward-looking statements and should be evaluated as such. Without
limiting the foregoing, the words "believes," "anticipates," "plans," "intends,"
"will," "expects," "should" and similar words and expressions are intended to
identify forward-looking statements. Except as required under the federal
securities laws or by the rules and regulations of the SEC, we assume no
obligation to update any such forward-looking information to reflect actual
results or changes in the factors affecting such forward-looking information.
The factors included in "Risks Relating to Our Business," among others, could
cause our actual results to differ materially from those expressed in, or
implied by, the forward-looking statements.
Specific factors that might cause actual results to differ from our
expectations, include, but are not limited to:
24
o economic, competitive, demographic, business and other conditions
in our markets;
o a decline in patient referrals;
o changes in the rates or methods of third-party reimbursement for
diagnostic imaging services;
o the enforceability or termination of our contracts with radiology
practices;
o the availability of additional capital to fund capital expenditure
requirements;
o burdensome lawsuits against our contracted radiology practices and
us;
o reduced operating margins due to our managed care contracts and
capitated fee arrangements;
o any failure on our part to comply with state and federal
anti-kickback and anti-self-referral laws or any other applicable
healthcare regulations;
o our substantial indebtedness, debt service requirements and
liquidity constraints;
o the interruption of our operations in certain regions due to
earthquake or other extraordinary events;
o the recruitment and retention of technologists by us or by
radiologists of our contracted radiology groups; and
o other factors discussed in the "Risk Factors" section or elsewhere
in this report.
All future written and verbal forward-looking statements attributable to us or
any person acting on our behalf are expressly qualified in their entirety by the
cautionary statements contained or referred to in this section. In light of
these risks, uncertainties and assumptions, the forward-looking events discussed
in this report might not occur.
RISKS RELATING TO OUR BUSINESS
WE MAY NOT BE ABLE TO GENERATE SUFFICIENT CASH FLOW TO MEET OUR DEBT SERVICE
OBLIGATIONS.
Our ability to generate sufficient cash flow from operations to make payments on
our debt and other contractual obligations will depend on our future financial
performance. A range of economic, competitive, regulatory, legislative and
business factors, many of which are outside of our control, will affect our
financial performance. Our inability to generate sufficient cash flow to satisfy
our debt and other contractual obligations would adversely impact our business,
financial condition and results of operations.
OUR ABILITY TO GENERATE REVENUE DEPENDS IN LARGE PART ON REFERRALS FROM
PHYSICIANS.
A significant reduction in referrals would have a negative impact on our
business. We derive substantially all of our net revenue, directly or
indirectly, from fees charged for the diagnostic imaging services performed at
our facilities. We depend on referrals of patients from unaffiliated physicians
and other third parties who have no contractual obligations to refer patients to
us for a substantial portion of the services we perform. If a sufficiently large
number of these physicians and other third parties were to discontinue referring
patients to us, our scan volume could decrease, which would reduce our net
revenue and operating margins. Further, commercial third-party payors have
implemented programs that could limit the ability of physicians to refer
patients to us. For example, prepaid healthcare plans, such as health
maintenance organizations, sometimes contract directly with providers and
require their enrollees to obtain these services exclusively from those
providers. Some insurance companies and self-insured employers also limit these
services to contracted providers. These "closed panel" systems are now common in
the managed care environment, including California. Other systems create an
economic disincentive for referrals to providers outside the system's designated
panel of providers. If we are unable to compete successfully for these managed
care contracts, our results and prospects for growth could be adversely
affected.
CHANGES IN THIRD-PARTY REIMBURSEMENT RATES OR METHODS FOR DIAGNOSTIC IMAGING
SERVICES COULD RESULT IN A DECLINE IN OUR NET REVENUE AND NEGATIVELY IMPACT OUR
BUSINESS.
25
The fees for diagnostic imaging services performed at our facilities are paid by
insurance companies, Medicare and Medi-Cal, workers compensation, private and
other payors. Any change in the rates of or conditions for reimbursement from
these sources of payment could substantially reduce the amounts reimbursed to us
or to our contracted radiology practices for services provided, which could have
an adverse effect on our net revenue.
PRESSURE TO CONTROL HEALTHCARE COSTS COULD HAVE A NEGATIVE IMPACT ON OUR
RESULTS.
One of the principal objectives of health maintenance organizations and
preferred provider organizations is to control the cost of healthcare services.
Managed care contracting has become very competitive, and reimbursement
schedules are at or below Medicare reimbursement levels. The development and
expansion of health maintenance organizations, preferred provider organizations
and other managed care organizations within the geographic areas covered by our
network could have a negative impact on the utilization and pricing of our
services, because these organizations will exert greater control over patients'
access to diagnostic imaging services, the selections of the provider of such
services and reimbursement rates for those services.
IF BRMG OR ANY OF OUR OTHER CONTRACTED RADIOLOGY PRACTICES TERMINATE THEIR
AGREEMENTS WITH US, OUR BUSINESS COULD SUBSTANTIALLY DIMINISH.
Our relationship with BRMG is an integral part of our business. Through our
management agreement, BRMG provides all of the professional medical services at
42 of our 57 facilities, contracts with various other independent physicians and
physician groups to provide all of the professional medical services at most of
our other facilities, and must use its best efforts to provide the professional
medical services at any new facilities that we open or acquire. In addition,
BRMG's strong relationships with referring physicians are largely responsible
for the revenue generated at the facilities it services. Although our management
agreement with BRMG runs until 2014, BRMG has the right to terminate the
agreement if we default on our obligations and fail to cure the default. Also,
BRMG's ability to continue performing under the management agreement may be
curtailed or eliminated due to BRMG's financial difficulties, loss of physicians
or other circumstances. If BRMG cannot perform its obligation to us, we would
need to contract with one or more other radiology groups to provide the
professional medical services at the facilities serviced by BRMG. We may not be
able to locate radiology groups willing to provide those services on terms
acceptable to us, if at all. Even if we were able to do so, any replacement
radiology group's relationships with referring physicians may not be as
extensive as those of BRMG. In any such event, our business could be seriously
harmed. In addition, BRMG is party to substantially all of the managed care
contracts from which we derive revenue. If we were unable to readily replace
these contracts, our revenue would be negatively affected.
Except for our management agreement with BRMG, most of the agreements we or BRMG
have with contracted radiology practices typically have terms of one year, which
automatically renew unless either party delivers a non-renewal notice to the
other within a prescribed period. Most of these agreements may be terminated by
either party under some conditions, including, with respect to some of those
agreements, the right of either party to terminate the agreement without cause
upon 30 to 120 days notice. For example, in October 2003, our management
agreement with Tower Imaging Medical Group, Inc. was terminated as the result of
the settlement of litigation between Tower and us. The termination or material
modification of any of the agreements we or BRMG have with the radiologists that
provide professional medical services at our facilities could reduce our
revenue, at least in the short term.
IF OUR CONTRACTED RADIOLOGY PRACTICES, INCLUDING BRMG, LOSE A SIGNIFICANT NUMBER
OF THEIR RADIOLOGISTS, OUR FINANCIAL RESULTS COULD BE ADVERSELY AFFECTED.
Recently, there has been a shortage of qualified radiologists in some of the
regional markets we serve. In addition, competition in recruiting radiologists
may make it difficult for our contracted radiology practices to maintain
adequate levels of radiologists. If a significant number of radiologists
terminate their relationships with our contracted radiology practices and those
radiology practices cannot recruit sufficient qualified radiologists to fulfill
their obligations under our agreements with them, our ability to maximize the
use of our diagnostic imaging facilities and our financial results could be
adversely affected. For example, in fiscal 2002, due to a shortage of qualified
26
radiologists in the marketplace, BRMG experienced difficulty in hiring and
retaining physicians and thus engaged independent contractors and part-time
fill-in physicians. Their cost was double the salary of a regular BRMG full-time
physician. Increased expenses to BRMG will impact our financial results because
the management fee we receive from BRMG, which is based on a percentage of
BRMG's collections, is adjusted annually to take into account the expenses of
BRMG. Neither we nor our contracted radiology practices maintain insurance on
the lives of any affiliated physicians.
WE MAY NOT BE ABLE TO SUCCESSFULLY GROW OUR BUSINESS.
As part of our business strategy, we intend to increase our presence in
California through selectively acquiring facilities, developing new facilities,
adding equipment at existing facilities, and directly or indirectly through BRMG
entering into contractual relationships with high-quality radiology practices.
However, our ability to successfully expand depends upon many factors, including
our ability to:
o Identify attractive and willing candidates for acquisitions;
o Identify locations in existing or new markets for development of
new facilities;
o Comply with legal requirements affecting our arrangements with
contracted radiology practices, including California prohibitions
on fee-splitting, corporate practice of medicine and
self-referrals;
o Obtain regulatory approvals where necessary and comply with
licensing and certification requirements applicable to our
diagnostic imaging facilities, the contracted radiology practices
and the physicians associated with the contracted radiology
practices;
o Recruit a sufficient number of qualified radiology technologists
and other non-medical personnel;
o Expand our infrastructure and management; and
o Our ability to expand also depends on our ability to compete for
opportunities. We may not be able to compete effectively for the
acquisition of diagnostic imaging facilities. Our competitors may
have more established operating histories and greater resources
than we do. Competition also may make any acquisitions more
expensive.
Acquisitions involve a number of special risks, including the following:
o Obtain adequate financing.
o Possible adverse effects on our operating results;
o Diversion of management's attention and resources;
o Failure to retain key personnel;
o Difficulties in integrating new operations into our existing
infrastructure; and
o Amortization or write-offs of acquired intangible assets.
WE MAY BECOME SUBJECT TO PROFESSIONAL MALPRACTICE LIABILITY.
Providing medical services subjects us to the risk of professional malpractice
and other similar claims. The physicians that our contracted radiology practices
employ are from time to time subject to malpractice claims. We structure our
relationships with the practices under our management agreements with them in a
manner that we believe does not constitute the practice of medicine by us or
subject us to professional malpractice claims for acts or omissions of
physicians employed by the contracted radiology practices. Nevertheless, claims,
suits or complaints relating to services provided by the contracted radiology
practices have been asserted against us in the past and may be asserted against
us in the future. In addition, we may be subject to professional liability
claims, including, without limitation, for improper use or malfunction of our
diagnostic imaging equipment. We may not be able to maintain adequate liability
insurance to protect us against those claims at acceptable costs or at all.
27
Any claim made against us that is not fully covered by insurance could be costly
to defend, result in a substantial damage award against us and divert the
attention of our management from our operations, all of which could have an
adverse effect on our financial performance. In addition, successful claims
against us may adversely affect our business or reputation. Although California
places a $250,000 limit on non-economic damages for medical malpractice cases,
no limit applies to economic damages.
SOME OF OUR IMAGING MODALITIES USE RADIOACTIVE MATERIALS, WHICH GENERATE
REGULATED WASTE AND COULD SUBJECT US TO LIABILITIES FOR INJURIES OR VIOLATIONS
OF ENVIRONMENTAL AND HEALTH AND SAFETY LAWS.
Some of our imaging procedures use radioactive materials, which generate medical
and other regulated wastes. For example, patients are injected with a
radioactive substance before undergoing a PET scan. Storage, use and disposal of
these materials and waste products present the risk of accidental environmental
contamination and physical injury. We are subject to federal, California and
local regulations governing storage, handling and disposal of these materials.
We could incur significant costs and the diversion of our management's attention
in order to comply with current or future environmental and health and safety
laws and regulations. Also, we cannot completely eliminate the risk of
accidental contamination or injury from these hazardous materials. In the event
of an accident, we could be held liable for any resulting damages, and any
liability could exceed the limits of or fall outside the coverage of our
insurance.
WE EXPERIENCE COMPETITION FROM OTHER DIAGNOSTIC IMAGING COMPANIES AND HOSPITALS.
THIS COMPETITION COULD ADVERSELY AFFECT OUR REVENUE AND BUSINESS.
The market for diagnostic imaging services in California is highly competitive.
We compete principally on the basis of our reputation, our ability to provide
multiple modalities at many of our facilities, the location of our facilities
and the quality of our diagnostic imaging services. We compete locally with
groups of radiologists, established hospitals, clinics and other independent
organizations that own and operate imaging equipment. Our major national
competitors include Radiologix, Inc., Alliance Imaging, Inc., Healthsouth
Corporation and Insight Health Services. Some of our competitors may now or in
the future have access to greater financial resources than we do and may have
access to newer, more advanced equipment.
In addition, in the past some non-radiologist physician practices have refrained
from establishing their own diagnostic imaging facilities because of the federal
physician self-referral legislation. Final regulations issued in January 2001
clarify exceptions to the physician self-referral legislation, which created
opportunities for some physician practices to establish their own diagnostic
imaging facilities within their group practices and to compete with us. In the
future, we could experience significant competition as a result of those final
regulations.
TECHNOLOGICAL CHANGE IN OUR INDUSTRY COULD REDUCE THE DEMAND FOR OUR SERVICES
AND REQUIRE US TO INCUR SIGNIFICANT COSTS TO UPGRADE OUR EQUIPMENT.
The development of new technologies or refinements of existing modalities may
require us to upgrade and enhance our existing equipment before we may otherwise
intend. Many companies currently manufacture diagnostic imaging equipment.
Competition among manufacturers for a greater share of the diagnostic imaging
equipment market may result in technological advances in the speed and imaging
capacity of new equipment. This may accelerate the obsolescence of our
equipment, and we may not have the financial ability to acquire the new or
improved equipment. In that event, we may be unable to deliver our services in
the efficient and effective manner in which payors, physicians and patients
expect and thus our revenue could substantially decrease.
WE HAVE EXPERIENCED OPERATING LOSSES AND WE HAVE A SUBSTANTIAL ACCUMULATED
DEFICIT. IF WE ARE UNABLE TO IMPROVE OUR FINANCIAL PERFORMANCE, WE MAY BE UNABLE
TO PAY OUR OBLIGATIONS.
We have incurred net losses of $2.8 million and $7.7 million during the nine
months ended July 31, 2005 and 2004, respectively, and at July 31, 2005 we had
an accumulated stockholders' deficit of $70.3 million. Also, in recent periods,
we have suffered liquidity shortfalls which have led us to, among other things,
undertake and complete a "pre-packaged" Chapter 11 plan of reorganization and
modify the terms of various of our financial obligations. While we believe that
by taking these and other actions in the future we will be able to address these
issues and solidify our financial condition, we cannot give assurances that we
will be able to generate sufficient cash flow from operations to satisfy our
debt obligations.
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A FAILURE TO MEET OUR CAPITAL EXPENDITURE REQUIREMENTS COULD ADVERSELY AFFECT
OUR BUSINESS.
We operate in a capital intensive, high fixed-cost industry that requires
significant amounts of capital to fund operations, particularly the initial
start-up and development expenses of new diagnostic imaging facilities and the
acquisition of additional facilities and new diagnostic imaging equipment. We
incur capital expenditures to, among other things, upgrade and replace existing
equipment for existing facilities and expand within our existing markets and
enter new markets. To the extent we are unable to generate sufficient cash from
our operations, funds are not available from our lenders or we are unable to
structure or obtain financing through operating leases, long-term installment
notes or capital leases, we may be unable to meet our capital expenditure
requirements.
BECAUSE WE HAVE HIGH FIXED COSTS, LOWER SCAN VOLUMES PER SYSTEM COULD ADVERSELY
AFFECT OUR BUSINESS.
The principal components of our expenses, excluding depreciation, consist of
compensation paid to physicians and technologists, salaries, real estate lease
expenses and equipment maintenance costs. Because a majority of these expenses
are fixed, a relatively small change in our revenue could have a
disproportionate effect on our operating and financial results depending on the
source of our revenue. Thus, decreased revenue as a result of lower scan volumes
per system could result in lower margins, which would adversely affect our
business.
OUR SUCCESS DEPENDS IN PART ON OUR KEY PERSONNEL AND WE MAY NOT BE ABLE TO
RETAIN SUFFICIENT QUALIFIED PERSONNEL. IN ADDITION, FORMER EMPLOYEES COULD USE
THE EXPERIENCE AND RELATIONSHIPS DEVELOPED WHILE EMPLOYED WITH US TO COMPETE
WITH US.
Our success depends in part on our ability to attract and retain qualified
senior and executive management, managerial and technical personnel. Competition
in recruiting these personnel may make it difficult for us to continue our
growth and success. The loss of their services or our inability in the future to
attract and retain management and other key personnel could hinder the
implementation of our business strategy. The loss of the services of Dr. Howard
G. Berger, our President and Chief Executive Officer, could have a significant
negative impact on our operations. We believe that he could not easily be
replaced with an executive of equal experience and capabilities. We do not
maintain key person insurance on the life of any of our executive officers with
the exception of a $5.0 million policy on the life of Dr. Berger. Also, if we
lose the services of Dr. Berger, our relationship with BRMG could deteriorate,
which would adversely affect our business.
Unlike many other states, California does not enforce agreements that prohibit a
former employee from competing with the former employer. As a result, any of our
employees whose employment is terminated is free to compete with us, subject to
prohibitions on the use of confidential information and, depending on the terms
of the employee's employment agreement, on solicitation of existing employees
and customers. A former executive, manager or other key employee who joins one
of our competitors could use the relationships he or she established with third
party payors, radiologists or referring physicians while our employee and the
industry knowledge he or she acquired during that tenure to enhance the new
employer's ability to compete with us.
CAPITATION FEE ARRANGEMENTS COULD REDUCE OUR OPERATING MARGINS.
For the nine months ended July 31, 2005, we derived approximately 26% of our net
revenue from capitation arrangements. Under capitation arrangements, the payor
pays a pre-determined amount per-patient per-month in exchange for us providing
all necessary covered services to the patients covered under the arrangement.
These contracts pass much of the financial risk of providing diagnostic imaging
services, including the risk of over-use, from the payor to the provider. Our
success depends in part on our ability to negotiate effectively, on behalf of
the contracted radiology practices and our diagnostic imaging facilities,
contracts with health maintenance organizations, employer groups and other
third-party payors for services to be provided on a capitated basis and to
efficiently manage the utilization of those services. If we are not successful
in managing the utilization of services under these capitation arrangements or
if patients or enrollees covered by these contracts require more frequent or
extensive care than anticipated, we would incur unanticipated costs not offset
by additional revenue, which would reduce operating margins.
WE MAY BE UNABLE TO EFFECTIVELY MAINTAIN OUR EQUIPMENT OR GENERATE REVENUE WHEN
OUR EQUIPMENT IS NOT OPERATIONAL.
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Timely, effective service is essential to maintaining our reputation and high
use rates on our imaging equipment. Although we have an agreement with GE
Medical Systems pursuant to which it maintains and repairs the majority of our
imaging equipment, this agreement does not compensate us for loss of revenue
when our systems are not fully operational and our business interruption
insurance may not provide sufficient coverage for the loss of revenue. Also, GE
Medical Systems may not be able to perform repairs or supply needed parts in a
timely manner. Therefore, if we experience more equipment malfunctions than
anticipated or if we are unable to promptly obtain the service necessary to keep
our equipment functioning effectively, our ability to provide services would be
adversely affected and our revenue could decline.
DISRUPTION OR MALFUNCTION IN OUR INFORMATION SYSTEMS COULD ADVERSELY AFFECT OUR
BUSINESS.
Our information technology system is vulnerable to damage or interruption from:
o Earthquakes, fires, floods and other natural disasters;
o Power losses, computer systems failures, internet and
telecommunications or data network failures, operator negligence,
improper operation by or supervision of employees, physical and
electronic losses of data and similar events; and
o Computer viruses, penetration by hackers seeking to disrupt
operations or misappropriate information, and other breaches of
security.
We rely on this system to perform functions critical to our ability to operate,
including patient scheduling, billing, collections, image storage and image
transmission. Accordingly, an extended interruption in the system's function
could significantly curtail, directly and indirectly, our ability to conduct our
business and generate revenue.
OUR ACTUAL FINANCIAL RESULTS MAY VARY SIGNIFICANTLY FROM THE PROJECTIONS WE
FILED WITH THE BANKRUPTCY COURT.
In connection with our "pre-packaged" Chapter 11 plan of reorganization that was
confirmed by the Bankruptcy Court on October 20, 2003, we were required to
prepare projected financial information to demonstrate to the Bankruptcy Court
the feasibility of the plan of reorganization and our ability to continue
operations upon our emergence from bankruptcy. As indicated in the disclosure
statement with respect to the plan of reorganization and the exhibits thereto,
the projected financial information and various estimates of value discussed
therein should not be regarded as representations or warranties by us or any
other person as to the accuracy of that information or that those projections or
valuations will be realized. We and our advisors prepared the information in the
disclosure statement, including the projected financial information and
estimates of value. This information was not audited or reviewed by our
independent accountants. The significant assumptions used in preparation of the
information and estimates of value were included as an exhibit to the disclosure
statement.
Those projections are not included in this report and you should not rely upon
them in any way or manner. We have not updated, nor will we update, those
projections. At the time we prepared the projections, they reflected numerous
assumptions concerning our anticipated future performance with respect to
prevailing and anticipated market and economic conditions which were and remain
beyond our control and which may not materialize. Projections are inherently
subject to significant and numerous uncertainties and to a wide variety of
significant business, economic and competitive risks and the assumptions
underlying the projections may be wrong in many material respects. Our actual
results may vary significantly from those contemplated by the projections. As a
result, we caution you not to rely upon those projections.
WE ARE VULNERABLE TO EARTHQUAKES AND OTHER NATURAL DISASTERS.
Our headquarters and all of our facilities are located in California, an area
prone to earthquakes and other natural disasters. An earthquake or other natural
disaster could seriously impair our operations, and our insurance may not be
sufficient to cover us for the resulting losses.
COMPLYING WITH FEDERAL AND STATE REGULATIONS IS AN EXPENSIVE AND TIME-CONSUMING
PROCESS, AND ANY FAILURE TO COMPLY COULD RESULT IN SUBSTANTIAL PENALTIES.
We are directly or indirectly through the radiology practices with which we
contract subject to extensive regulation by both the federal government and the
State of California, including:
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o The federal False Claims Act;
o The federal Medicare and Medicaid anti-kickback laws, and
California anti-kickback prohibitions;
o Federal and California billing and claims submission laws and
regulations;
o The federal Health Insurance Portability and Accountability Act of
1996;
o The federal physician self-referral prohibition commonly known as
the Stark Law and the California equivalent of the Stark Law;
o California laws that prohibit the practice of medicine by
non-physicians and prohibit fee-splitting arrangements involving
physicians;
o Federal and California laws governing the diagnostic imaging and
therapeutic equipment we use in our business concerning patient
safety, equipment operating specifications and radiation exposure
levels; and
o California laws governing reimbursement for diagnostic services
related to services compensable under workers compensation rules.
If our operations are found to be in violation of any of the laws and
regulations to which we or the radiology practices with which we contract are
subject, we may be subject to the applicable penalty associated with the
violation, including civil and criminal penalties, damages, fines and the
curtailment of our operations. Any penalties, damages, fines or curtailment of
our operations, individually or in the aggregate, could adversely affect our
ability to operate our business and our financial results. The risks of our
being found in violation of these laws and regulations is increased by the fact
that many of them have not been fully interpreted by the regulatory authorities
or the courts, and their provisions are open to a variety of interpretations.
Any action brought against us for violation of these laws or regulations, even
if we successfully defend against it, could cause us to incur significant legal
expenses and divert our management's attention from the operation of our
business.
IF WE FAIL TO COMPLY WITH VARIOUS LICENSURE, CERTIFICATION AND ACCREDITATION
STANDARDS, WE MAY BE SUBJECT TO LOSS OF LICENSURE, CERTIFICATION OR
ACCREDITATION, WHICH WOULD ADVERSELY AFFECT OUR OPERATIONS.
Ownership, construction, operation, expansion and acquisition of our diagnostic
imaging facilities are subject to various federal and California laws,
regulations and approvals concerning licensing of personnel, other required
certificates for certain types of healthcare facilities and certain medical
equipment. In addition, freestanding diagnostic imaging facilities that provide
services independent of a physician's office must be enrolled by Medicare as an
independent diagnostic testing facility to bill Medicare. Medicare carriers have
discretion in applying the independent diagnostic testing facility requirements
and therefore the application of these requirements may vary from jurisdiction
to jurisdiction. We may not be able to receive the required regulatory approvals
for any future acquisitions, expansions or replacements, and the failure to
obtain these approvals could limit the opportunity to expand our services.
Our facilities are subject to periodic inspection by governmental and other
authorities to assure continued compliance with the various standards necessary
for licensure and certification. If any facility loses its certification under
the Medicare program, then the facility will be ineligible to receive
reimbursement from the Medicare and Medi-Cal programs. For the nine months ended
July 31, 2005, approximately 18% of our net revenue came from the Medicare and
Medi-Cal programs. A change in the applicable certification status of one of our
facilities could adversely affect our other facilities and in turn us as a
whole.
OUR AGREEMENTS WITH THE CONTRACTED RADIOLOGY PRACTICES MUST BE STRUCTURED TO
AVOID THE CORPORATE PRACTICE OF MEDICINE AND FEE-SPLITTING.
California law prohibits us from exercising control over the medical judgments
or decisions of physicians and from engaging in certain financial arrangements,
such as splitting professional fees with physicians. These laws are enforced by
state courts and regulatory authorities, each with broad discretion. A component
of our business has been to enter into management agreements with radiology
practices. We provide management, administrative, technical and other
non-medical services to the radiology practices in exchange for a service fee
typically based on a percentage of the practice's revenue. We structure our
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relationships with the radiology practices, including the purchase of diagnostic
imaging facilities, in a manner that we believe keeps us from engaging in the
practice of medicine or exercising control over the medical judgments or
decisions of the radiology practices or their physicians or violating the
prohibitions against fee-splitting. However, because challenges to these types
of arrangements are not required to be reported, we cannot substantiate our
belief. There can be no assurance that our present arrangements with BRMG or the
physicians providing medical services and medical supervision at our imaging
facilities will not be challenged, and, if challenged, that they will not be
found to violate the corporate practice prohibition, thus subjecting us to
potential damages, injunction and/or civil and criminal penalties or require us
to restructure our arrangements in a way that would affect the control or
quality of our services and/or change the amounts we receive under our
management agreements. Any of these results could jeopardize our business.
FUTURE FEDERAL LEGISLATION COULD LIMIT THE PRICES WE CAN CHARGE FOR OUR
SERVICES, WHICH WOULD REDUCE OUR REVENUE AND ADVERSELY AFFECT OUR OPERATING
RESULTS.
In addition to extensive existing government healthcare regulation, there are
numerous initiatives affecting the coverage of and payment for healthcare
services, including proposals that would significantly limit reimbursement under
the Medicare and Medi-Cal programs. Limitations on reimbursement amounts and
other cost containment pressures have in the past resulted in a decrease in the
revenue we receive for each scan we perform. It is not clear at this time what
additional proposals, if any, will be made or adopted or, if adopted, what
effect these proposals would have on our business.
THE REGULATORY FRAMEWORK IN WHICH WE OPERATE IS UNCERTAIN AND EVOLVING.
Healthcare laws and regulations may change significantly in the future. We
continuously monitor these developments and modify our operations from time to
time as the regulatory environment changes. We cannot assure you, however, that
we will be able to adapt our operations to address new regulations or that new
regulations will not adversely affect our business. In addition, although we
believe that we are operating in compliance with applicable federal and
California laws, neither our current or anticipated business operations nor the
operations of the contracted radiology practices have been the subject of
judicial or regulatory interpretation. We cannot assure you that a review of our
business by courts or regulatory authorities will not result in a determination
that could adversely affect our operations or that the healthcare regulatory
environment will not change in a way that restricts our operations.
Certain states have enacted statutes or adopted regulations affecting risk
assumption in the healthcare industry, including statutes and regulations that
subject any physician or physician network engaged in risk-based managed care
contracting to applicable insurance laws and regulations. These laws and
regulations, if adopted in California, may require physicians and physician
networks to meet minimum capital requirements and other safety and soundness
requirements. Implementing additional regulations or compliance requirements
could result in substantial costs to us and the contracted radiology practices
and limit our ability to enter into capitation or other risk sharing managed
care arrangements.
OUR SUBSTANTIAL DEBT COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND PREVENT
US FROM FULFILLING OUR OBLIGATIONS.
Our current substantial indebtedness and any future indebtedness we incur could
have important consequences by adversely affecting our financial condition,
which could make it more difficult for us to satisfy our obligations to our
creditors. Our substantial indebtedness could also:
o Require us to dedicate a substantial portion of our cash flow from
operations to payments on our debt, reducing the availability of
our cash flow to fund working capital, capital expenditures and
other general corporate purposes;
o Increase our vulnerability to adverse general economic and
industry conditions;
o Limit our flexibility in planning for, or reacting to, changes in
our business and the industry in which we operate;
o Place us at a competitive disadvantage compared to our competitors
that have less debt; and
o Limit our ability to borrow additional funds on terms that are
satisfactory to us or at all.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
We sell our services exclusively in the United States and receive payment for
our services exclusively in United States dollars. As a result, our financial
results are unlikely to be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets.
The majority of our interest expense is not sensitive to changes in the general
level of interest in the United States because the majority of our indebtedness
has interest rates that were fixed when we entered into the note payable or
capital lease obligation. None of our long-term liabilities have variable
interest rates. Our credit facility, classified as a current liability on our
financial statements, is interest expense sensitive to changes in the general
level of interest because it is based upon the current prime rate plus a factor.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
As required by Rule 13a-15(b) of the Exchange Act, our management, including the
Chief Executive Officer and Chief Financial Officer, conducted an evaluation as
of the end of the period covered by this Quarterly Report, of the effectiveness
of our disclosure controls and procedures as defined in Exchange Act Rule
13a-15(e). Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this Quarterly Report. As
required by Rule 13a-15(d), our management, including the Chief Executive
Officer and Chief Financial Officer, also conducted an evaluation of our
internal control over financial reporting to determine whether any changes
occurred during the period covered by this Quarterly Report that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that there has been no such change during
the period covered by this Quarterly Report that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
It should be noted that any system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system will be met. In addition, the design of any control
system is based in part upon certain assumptions about the likelihood of future
events.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are engaged from time to time in the defense of lawsuits arising out
of the ordinary course and conduct of our business. We believe that the
outcome of our current litigation will not have a material adverse
impact on our business, financial condition and results of operations.
However, we could be subsequently named as a defendant in other
lawsuits that could adversely affect us.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
There are no matters to be reported under this heading.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There are no matters to be reported under this heading.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There are no matters to be reported under this heading.
ITEM 5. OTHER INFORMATION
To assist with our financial liquidity in June 2005, Howard G. Berger,
M.D., our president, director and largest shareholder loaned us
$1,370,000. Interest and principal payments will not be made until such
time as our loans to Post Advisory Group (approximately $16.9 million
as of July 31, 2005) has been paid in full.
Effective September 14, 2005, we established a new $20 million working
capital revolving credit facility with Bridge Healthcare Finance, or
Bridge, a specialty lender in the healthcare industry. Upon the
establishment of this credit facility, we borrowed $15.5 million which
was used to pay off the entire balance of our existing credit facility
with Wells Fargo Foothill. Upon repayment, the existing credit facility
with Wells Fargo Foothill was terminated. Additionally, Bridge provided
us approximately $0.8 million in the form of a term loan, which we used
to pay the balance of a term loan owed to Wells Fargo Foothill. Under
the Bridge revolving credit facility, we may borrow the lesser of 85%
of the net collectible value of eligible accounts receivable plus one
month capitation receipts for the preceding month, or $20,000,000. An
overadvance subline is available not to exceed $2,000,000, so long as
after giving effect to the overadvance subline, the revolver usage does
not exceed $20,000,000. Eligible accounts receivable shall exclude
those accounts older than 150 days from invoice date and will be net of
customary reserves. Dr. Berger has agreed to personally guaranty the
repayment of any monies under the overadvance subline. Advances under
the revolving loan bear interest at the base rate plus 3.25%. The base
rate refers to the prime rate publicly announced by La Salle Bank
National Association, in effect from time to time. The term loan bears
interest at the annual rate of 12.50%. The revolving credit facility is
collateralized by substantially all of our accounts receivable and
requires us to meet certain financial covenants including minimum
levels of EBITDA, fixed charge coverage ratios and maximum senior
debt/EBITDA ratios. The term loan is collateralized by specific imaging
equipment used by us at certain of our locations. As part of the Bridge
Healthcare financing, our financial covenants were revised with our
creditors, including GE, US Bank and Post Advisory Group.
ITEM 6. EXHIBITS
a) Exhibit 31.1 -- Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
b) Exhibit 31.2 -- Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
c) Exhibit 32.1 -- Certification Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
d) Exhibit 32.2 -- Certification Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of
e) No reports on Form 8-K have been filed during the quarter for which
this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PRIMEDEX HEALTH SYSTEMS, INC.
----------------------------------------------
(Registrant)
Date: September 14, 2005 By /s/ HOWARD G. BERGER, M.D.
----------------------------------------------
Howard G. Berger, M.D., President and Director
(Principal Executive Officer)
Date: September 14, 2005 By /s/ MARK D. STOLPER
----------------------------------------------
Mark D. Stolper, Chief Financial Officer
(Principal Accounting Officer)
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