UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1997
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 0-28622
INSIGHT HEALTH SERVICES CORP.
(Exact name of Registrant as specified in its charter)
DELAWARE 33-0702770
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification
organization) No.)
4400 MACARTHUR BLVD., SUITE 800, NEWPORT BEACH, CA 92660
(Address of principal executive offices) (Zip Code)
(714) 476-0733
(Registrant's telephone number including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained to the best
of the Registrant's knowledge, in definitive proxy or informative statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _______
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of September 30, 1997 (based on the closing price on the NASDAQ
Small Cap Market on that date) was $14,452,668.
The number of shares outstanding of the Registrant's Common Stock as of
September 30, 1997 was 2,714,725.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the next Annual Meeting of Stockholders
of the Registrant are incorporated herein by reference in Part III.
Certain exhibits are incorporated herein by reference as set forth in Item
14(a)(3), Exhibits, in Part IV.
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PART I
ITEM 1. BUSINESS
MERGER
InSight Health Services Corp. ("InSight" or the "Company") is a Delaware
corporation formed on February 23, 1996 in connection with the Agreement and
Plan of Merger, dated as of February 26, 1996 (the "Merger Agreement"), among
American Health Services Corp., a Delaware corporation ("AHS"), Maxum Health
Corp., a Delaware corporation ("MHC" or "Maxum"), InSight and two wholly owned
subsidiaries of InSight, AHSC Acquisition Company, a Delaware corporation ("AHSC
Acquisition"), and MXHC Acquisition Company, a Delaware corporation ("MXHC
Acquisition"). Each of AHS and MHC were publicly held providers of diagnostic
imaging, treatment and related management services. Pursuant to the terms of the
Merger Agreement, (i) AHSC Acquisition merged with and into AHS and MXHC
Acquisition merged with and into Maxum (collectively, the "Merger"), (ii) each
outstanding share of common stock, par value $.03 per share, of AHS ("AHS Common
Stock") was converted into the right to receive one-tenth of a share of common
stock, par value $.001 per share, of InSight ("InSight Common Stock"), (iii)
each outstanding share of Series B Senior Convertible Preferred Stock, par value
$.03 per share, of AHS ("AHS Series B Preferred Stock") which was convertible
into 100 shares of AHS Common Stock was converted into the right to receive 10
shares of InSight Common Stock, (iv) each outstanding share of Series C
Preferred Stock, par value $.03 per share, of AHS (the "AHS Series C Preferred
Stock"), which was issued immediately prior to the consummation of the Merger,
was converted into the right to receive 1.25088 shares of Series A Preferred
Stock, par value $.001 per share, of InSight (the "InSight Series A Preferred
Stock"), (v) each outstanding share of common stock, par value $.01 per share,
of Maxum ("Maxum Common Stock") was converted into the right to receive .598 of
a share of InSight Common Stock, (vi) each outstanding share of Series B
Preferred Stock, par value $.01 per share, of Maxum (the "Maxum Series B
Preferred Stock"), which was issued immediately prior to the consummation of the
Merger, was converted into the right to receive 83.392 shares of InSight Series
A Preferred Stock, and (vii) each outstanding option, warrant or other right to
purchase AHS Common Stock and Maxum Common Stock was converted into the right to
acquire, on the same terms and conditions, shares of InSight Common Stock, with
the number of shares and exercise price applicable to such option, warrant or
other right adjusted based on the applicable exchange ratio for the underlying
AHS Common Stock or Maxum Common Stock.
On June 25, 1996, the stockholders of both MHC and AHS approved the Merger. On
June 26, 1996, MHC and AHS became wholly owned subsidiaries of InSight, and the
stockholders of MHC and AHS became stockholders of InSight. MHC and AHS were
organized in 1989 and 1982, respectively.
On September 13, 1996, AHS changed its name to InSight Health Corp. ("IHC").
The principal executive offices of InSight are located at 4400 MacArthur Blvd.,
Suite 800, Newport Beach, California 92660, and its telephone number is (714)
476-0733.
RECAPITALIZATION
On October 14, 1997, InSight consummated a recapitalization
("Recapitalization") pursuant to which (a) certain investors affiliated with
TC Group, LLC and its affiliates (collectively, "Carlyle"), a private
merchant bank headquartered in Washington, D.C., made a cash investment of
$25 million in the Company and received therefor (i) 25,000 shares of newly
issued InSight Convertible Preferred Stock, Series B, par value $0.001 per
share ("Series B Preferred Stock"), initially convertible, at the option of
the holders thereof, in the aggregate into 2,985,075 shares of InSight Common
Stock, and (ii) warrants (the "Carlyle Warrants") to purchase up to 250,000
shares of InSight Common Stock at the current exercise price of $10.00 per
share; (b) General Electric Company ("GE") (i) surrendered its rights with
respect to its supplemental service fee (see Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
below) in exchange for (A) the issuance of 7,000 shares of newly issued
InSight Convertible Preferred Stock, Series C, par value $0.001 per share
("Series C Preferred Stock"), initially convertible, at the option of the
holders thereof, in the aggregate into 835,821 shares of InSight Common
Stock, and (B) warrants (the "GE Warrants") to purchase up to 250,000 shares
of InSight Common Stock at the current exercise price of $10.00 per share,
and (ii) agreed to exchange all of its InSight Convertible Preferred Stock,
Series A, on the business day (the "Second Closing") after all waiting
periods with respect to GE's filing under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, have expired or been terminated, for an
additional 20,953 shares of Series C Preferred Stock, initially convertible,
at the option of the holders thereof, in the aggregate into 2,501,760 shares
of InSight Common Stock; and (c) the Company executed a Credit Agreement with
NationsBank,
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N.A. pursuant to which NationsBank, as agent, committed to provide a total of
$125 million in senior secured credit, including a $50 million acquisition
facility, upon the satisfaction of certain customary conditions (the "Bank
Financing").
Pursuant to the terms of the Recapitalization, the number of directors
comprising the Company's Board of Directors (the "Board") is currently fixed
at nine. Six directors (the "Common Stock Directors") are to be elected by
the common stockholders, one of whom (the "Joint Director") is to be proposed
by Carlyle and GE and approved by a majority of the Board in its sole
discretion. Of the three remaining directors, two are to be elected by the
holders of the Series B Preferred Stock and one is to be elected by the
holders of the Series C Preferred Stock, subject to increase and decrease in
certain circumstances. Presently, the Board of Directors of the Company
consists of seven directors, five of whom are Common Stock Directors and two
of whom are Preferred Stock Directors elected by Carlyle. GE has informed
the Company of its intention to wait until the Second Closing to elect its
Preferred Stock Director. The vacancy created for the Joint Director has not
been filled.
CENTERS IN OPERATION
InSight provides diagnostic imaging, treatment and related management services
in 26 states throughout the United States. InSight's services are provided
through a network of 35 mobile magnetic resonance imaging ("MRI") facilities
("Mobile Facilities"), 28 fixed-site MRI facilities ("Fixed Facilities"), ten
multi-modality imaging centers ("Centers"), two Leksell Stereotactic Gamma Unit
treatment centers ("Gamma Knife"), and one radiation oncology center. An
additional radiation oncology center is operated by the Company as part of one
of its Centers. The Company's operations are located throughout the United
States, with a substantial presence in California, primarily Los Angeles county,
and northern Texas, primarily the Dallas-Ft. Worth metroplex.
At its Centers, InSight offers other services in addition to MRI including
diagnostic and fluoroscopic x-ray, mammography, diagnostic ultrasound, nuclear
medicine, nuclear cardiology, computed tomography ("CT") and cardiovascular
services. The Company offers additional services through a variety of
arrangements including equipment rental, technologist services and
training/applications, marketing, radiology management services, patient
scheduling, utilization review and billing and collection services.
DIAGNOSTIC IMAGING AND TREATMENT TECHNOLOGY
During approximately the last 20 years, there has been a major effort undertaken
by the medical and scientific communities to develop cost-effective diagnostic
imaging technologies and to minimize the risks associated with the application
of such technologies. The major categories of diagnostic imaging systems
currently offered in the medical marketplace are conventional x-ray, CT
scanners, digital ultrasound systems, computer-based nuclear gamma cameras,
radiography/fluoroscopy systems and MRI systems, each of which (other than
conventional x-ray) represents the marriage of computer technology and various
medical imaging modalities. Patients exposed to x-rays and to gamma rays
employed in nuclear medicine receive potentially harmful ionizing radiation.
Much of the thrust of product development during the period has been to reduce
the hazards associated with conventional x-ray and nuclear medicine techniques
and to develop new, virtually harmless imaging technologies such as ultrasound
and MRI.
X-RAY X-ray is the most common energy source used in imaging the body and is
now employed in the three following imaging modalities: (i) conventional x-ray
systems, the oldest method of imaging, are typically used to image bones and
contrast-enhanced vasculature and organs and constitute the largest number of
installed systems; (ii) CT scanners utilize computers to produce cross-sectional
images of particular organs or areas of the body; and (iii) digital x-ray
systems add computer image processing capability to conventional x-ray systems.
ULTRASOUND Ultrasound systems emit, detect and process high frequency sound
waves to generate images of soft tissues and internal body organs. The sound
waves used in ultrasound do not involve ionizing radiation and are not known to
cause any harmful effects to the patient.
NUCLEAR MEDICINE Nuclear medicine gamma cameras, which are based upon the
detection of gamma radiation generated by radioactive pharmaceuticals injected
or inhaled into the body, are used to provide information about organ function
as opposed to anatomical structure.
MRI TECHNOLOGY InSight believes that the introduction of MRI technology into
the health care marketplace marked a significant advance in diagnostic
medicine. Magnetic resonance is a technique that utilizes low energy
radiowaves to manipulate protons (usually hydrogen) in the body. MRI systems
place patients in a magnetic field. Once in the magnetic field, the protons
in a patient's body will tend to align with the magnetic field. Radio
frequency ("RF") waves, produced by a radio antenna coil which surrounds the
body part to be imaged, are "pulsed"
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against the magnetic field. The RF energy is then turned off, and the protons
are observed for different types of behavior, movement or "relaxation."
Different tissues have different relaxation times, depending on the amount of
hydrogen or water in each proton. The data on each proton's behavior is
collected digitally by the system's computer and then reconstructed into
cross-sectional images in three dimensional planes of orientation. The resulting
image reproduces soft tissue anatomy (as found in the brain, spinal cord and
interior ligaments of body joints such as the knee) with superior clarity, not
available by any other currently existing imaging modality. A typical MRI
examination takes from 30 to 90 minutes. MRI systems are typically priced in the
range of $0.9 million to $2 million each, depending upon the system
configuration, magnet design and field strength.
There are no known hazards to the general population from magnetic and RF fields
of the intensity to which a patient is exposed in a clinical MRI system.
Equipment literature nonetheless recommends that, until further information is
available, pregnant women should be scanned only under limited circumstances.
Furthermore, MRI magnets may disrupt the operation of cardiac pacemakers and may
react with ferrous clips utilized in various surgical procedures, so that
individuals with such devices may be excluded from examination with MRI systems,
and access to the area surrounding the MRI facility may also be controlled to
avoid these possible hazards. Additionally, some MRI examinations require
injection of a paramagnetic contrast material. Although it is extremely unusual,
some patients may develop a significant adverse reaction to this contrast
material; however, chances of fatalities as a result of such reaction are
remote.
Because the signals used to produce magnetic resonance images contain both
chemical and structural information, InSight believes this technique has greater
potential for many important diagnostic applications than any other imaging
technology currently in use. While existing MRI systems demonstrate excellent
portrayals of anatomical structures within the human body, of even greater
significance is the fact that MRI is also sensitive to subtle differences
between tissues. Thus, MRI offers not only the opportunity for highly effective
classical diagnosis, but also the potential for future monitoring of chemical
processes within the body.
Recent technological advances in software and gradient coil technology for MRI
systems have allowed equipment with lower magnetic field strength and open
architecture design to offer significantly improved image quality. These systems
use permanent electromagnetic technology rather than superconductivity magnets,
substantially lowering both siting and service costs. The open design allows for
studies not normally possible in conventional MRI systems, including
claustrophobic patients, extremely large patients (from 300 to 400 pounds) and
for musculoskeletal exams which require the patient to move or flex, such as
kinematic knee studies. Manufacturers are marketing these open MRI systems at
costs below most state Certificate of Need ("CON") requirements. The reduced
equipment costs, combined with lower siting and service expense, may make MRI
technology feasible at some rural hospitals and other new market locations where
patient volume and reimbursement do not financially justify the expense of a
conventional MRI system. Open MRI systems are priced in the range of $0.6
million to $1 million.
CT CT technology consists of a doughnut-shaped gantry structure into which a
patient, resting on a remotely controlled couch assembly, is positioned to scan
the anatomical region of interest. The scanning process is performed by the
rotation of a high output x-ray tube around the patient. The x-ray tube emits a
thin fan-shaped beam of x-rays that passes through the patient and is absorbed
by an array of x-ray detectors located on the opposite side of the patient from
the x-ray tube. The detected x-rays are then converted into digital measurements
of x-ray intensity directly proportional to the density of the portion of the
patient through which the beam passes. These digital measurements of x-ray
intensity are then processed by a specialized image reconstruction computer
system into a cross-sectional image of the anatomical region of interest. The
patient is then indexed on the couch and another scan performed and then
another, creating a "stack" of cross-sectional images constituting the complete
diagnostic imaging procedure.
Typical scanning times for a single cross-sectional image are in the one second
to six second range. A complete CT examination takes from 15 minutes to 45
minutes, depending on the complexity of the examination and number of individual
cross-sectional images required. The current selling prices of CT systems fall
in the range of $0.3 million to $1.5 million depending upon the specific
performance characteristics of the systems. Based on the fact that CT systems
have been commercially marketed for approximately 20 years, InSight believes
that CT is a relatively mature technology and, therefore, not subject to
significant risk of obsolescence.
4
Certain CT examinations require the injection of an iodine-based contrast
material, allowing for better visualization of the anatomy. Although it is very
unusual, some patients may develop a significant adverse reaction to this
contrast material. Fatalities as a result of such reaction have occurred but are
rare. In an effort to scan only appropriate patients, all patients are required
to answer a questionnaire which helps to identify those patients who may suffer
an adverse reaction to this contrast material.
GAMMA KNIFE The Leksell Stereotactic Gamma Unit is a state-of-the-art
radiosurgical device used to treat intracranial neoplasma and vascular anomalies
which are inaccessible or unsuitable for conventional invasive surgery. The
Gamma Knife was designed to provide neurosurgeons and radiation therapists with
the ability to perform radiosurgery, using high energy gamma rays, instead of
conventional invasive techniques (open surgery), thereby generally eliminating
the risk of infection and intracerebral bleeding.
The Gamma Knife delivers a single high dose of ionizing radiation emanating from
201 Cobalt 60 sources positioned about a hemispherical, precision machined
cavity. Each individual beam is focused on a common target producing an intense
concentration of radiation at the target site, destroying the lesion while
spreading the entry radiation dose uniformly and harmlessly over the patient's
skull. The mechanical precision of the Gamma Knife at the target site is 1/10 of
one millimeter (0.1 mm), making the Gamma Knife an ideal treatment device for
treating small or medium-sized lesions in critical locations within the brain.
However, based upon the type, size and/or location of such lesions, not all
patients are candidates for radiosurgery. The mechanical precision of the Gamma
Knife is coupled with an extremely sharp fall-off in the radiation intensity
surrounding the target, resulting in a highly localized treatment effect,
sparing surrounding tissue.
The Gamma Knife treatment requires no open surgical intervention, no lengthy
hospital stay and no risk of post-surgical bleeding or infection. When compared
to the average length of stay and costs associated with conventional surgery,
the Gamma Knife greatly reduces the cost of neurosurgical treatment. Typical
treatment time is approximately 10 to 15 minutes per area of interest
("isocenter"). A key feature of the Gamma Knife is its ability to perform
treatments that require multiple isocenters. In addition, other applications for
the Gamma Knife are currently being developed. Investigative work is being
conducted to treat patients for chronic pain and motion disorders such as
Parkinson's disease, epilepsy and trigeminal neuralgia. These new applications
represent a significant new market for the Gamma Knife upon clinical acceptance.
The current selling price of a Gamma Knife system is approximately $3 million.
STRATEGY AND MARKETING
InSight believes a consolidation in the diagnostic imaging industry is occurring
and is necessary in order to provide surviving companies the opportunity to
achieve operating and administrative efficiencies through consolidation.
InSight's primary objective is to provide diagnostic imaging, treatment and
related management services to hospitals, physicians and their patients. The
Company does not engage in the practice of medicine. The strategy of InSight is
focused on five interrelated initiatives: (i) the consolidation of the highly
fragmented, diagnostic imaging industry through the acquisition of organizations
which either strategically fit into its regional networking strategy or provide
significant cost savings through the consolidation of duplicative
infrastructures, (ii) development of a radiology co-source product where InSight
will provide management services for radiology departments within hospitals,
(iii) development of regional networks of radiology providers and physicians
designed to provide the highest quality and most cost-effective unit of
diagnostic information to the broadest population in a given market, (iv)
development of a network of open MRI systems to protect InSight's existing high
field MRI market and to expand in markets in which InSight does not have a
presence and (v) new business initiatives focused on broadening its range of
services to managed care organizations, hospitals and physician management
companies to include radiology management services; information management
services; billing and collections; technologist services and training
applications; marketing; equipment rental and continued evaluation of
opportunities with emerging technologies. InSight believes that long-term
viability is contingent upon its ability to successfully participate in this
industry consolidation.
In fiscal 1997, InSight completed three acquisitions of Centers and Mobile
Facilities and in the first quarter of fiscal 1998, InSight completed one
acquisition of a Center and entered into a definitive agreement for the purchase
of another Center, subject to the satisfaction of certain conditions. Also, in
fiscal 1997, an open MRI system was installed and became operational at one of
the Company's Fixed Facilities and a second open MRI system was installed at one
of the Company's Centers, subject to the issuance of a CON. The CON has been
received and InSight expects the open MRI system to become operational in the
second quarter of 1998. In addition, in the first quarter of 1998, InSight
entered into two joint venture arrangements for the development of two open MRI
Centers.
5
The foregoing acquisitions and developments have been financed by GE. Upon
the effectiveness of the Bank Financing, the Company believes it will be well
positioned to pursue additional acquisition and development opportunities.
Certain statements contained in this report are forward-looking statements
that involve a number of risks and uncertainties. The factors that could
cause actual results to differ materially include the following: availability
of financing; limitations and delays in reimbursement by third-party payors;
contract renewals and financial stability of customers; technology changes;
governmental regulation; conditions within the health care environment;
adverse utilization trends for certain diagnostic imaging procedures;
aggressive competition; general economic factors; InSight's inability to
carry out its business strategy due to rising purchase prices of imaging
centers and companies; and the risk factors listed from time to time in
InSight's filings with the Securities and Exchange Commission.
GOVERNMENT REGULATION
The health care industry is highly regulated and changes in laws and
regulations can be significant. Changes in the law or new interpretation of
existing laws can have a material effect on permissible activities of
InSight, the relative costs associated with doing business and the amount of
reimbursement by government and other third-party payors. The federal
government and all states in which InSight currently operates regulate
various aspects of the Company's business. Failure to comply with these laws
could adversely affect InSight's ability to receive reimbursement for its
services and subject the Company and its officers to penalties.
Some states require hospitals and certain other health care facilities to
obtain a CON prior to the acquisition of major medical equipment such as an
MRI or Gamma Knife system. InSight believes that it will not be required to
obtain CONs in most of the states in which it intends to operate, since most
states no longer require non-hospital providers to obtain CONs and those
states that do offer exemptions for which the Company may qualify; however,
in those states where a CON is required, InSight has complied or will comply
with such requirements.
Beginning in late 1983, prospective payment regulations became effective
under the federal Medicare program. The Medicare program provides
reimbursement for hospitalization, physician, diagnostic and certain other
services to eligible persons 65 years of age and over and others considered
disabled. Providers of service are paid by the federal government in
accordance with regulations promulgated by the United States Department of
Health and Human Services and accept said payment, with nominal co-insurance
amounts required to be paid by the service recipient, as payment in full. In
general, these regulations provide for a specific overall fee which hospitals
may charge for inpatient treatment services based upon the diagnosis of the
patient. Because InSight mainly provides services to patients on an
outpatient basis, the prospective payment regulations do not materially
affect the Company's business. Although outpatient services are presently
exempt from prospective payment reimbursement, Congress has instructed the
Prospective Payment Assessment Commission to study alternative methods for
reimbursing hospitals for outpatient services, including prospective payment
methods, and the Medicare program has adopted fee scales for some diagnostic
services. Such congressional activity reflects industry-wide cost containment
pressures which InSight believes will affect all health care providers for
the foreseeable future.
Private health insurance programs generally have authorized the payment for
diagnostic imaging and Gamma Knife procedures on satisfactory terms and the
Health Care Financing Administration ("HCFA") has authorized reimbursement
under the federal Medicare program for all diagnostic imaging and Gamma Knife
services currently being provided by the Company. However, if Medicare
reimbursement is reduced, InSight believes that private health insurance
programs will also reduce reimbursement in response to reductions in
government reimbursement which could have an adverse impact on the Company's
business.
The Medicaid program is a combined federal and state program providing
coverage for low income persons. The specific services offered and
reimbursement methods vary from state to state. In many states, Medicaid
reimbursement is patterned after the Medicare program. Changes in Medicaid
program reimbursement are not expected to have a material adverse impact on
the Company's business. InSight is subject to state and federal laws
prohibiting payments for patient referrals and regulating reimbursement
procedures and practices under Medicare, Medicaid and other governmental
health care programs. The Medicare and Medicaid Patient and Program
Protection Act of 1987 ("1987 Act") prohibits financial arrangements designed
to induce patient referrals to providers of services which are paid for by
Medicare or Medicaid. Courts have, to date, interpreted these laws to apply
to a broad range of financial relationships. Several states also have
statutes prohibiting arrangements with health care providers which, while
similar in many respects to the 1987 Act, vary from state to state, are often
vague and have infrequently been interpreted by courts or regulatory
agencies. Due to the potentially broad proscriptions
6
contained in these federal and state laws, there can be no assurance that all
of InSight's business practices would be construed to comply with these laws
in all respects. However, in the situations where InSight contracts with
health care providers who may be in a position to refer patients to the
Company's operations, the Company exercises care in an effort to structure
its activities and arrangements to comply with applicable federal and state
laws. InSight maintains an internal regulatory compliance review program and
retains special counsel, as necessary, to monitor compliance with such laws
and regulations.
Under current Medicare policy, imaging centers may generally participate in
the Medicare program as either medical groups or, subject to the discretion
of individual Medicare carriers, Independent Physiological Laboratories
("IPLs"). The IPL is a loosely defined Medicare provider category that is
not specifically authorized to provide imaging services. Accordingly, certain
carriers permit IPLs to provide imaging services and others do not. In the
past, InSight has preferred, to the extent possible, to operate its imaging
centers for Medicare purposes as IPLs. InSight believes that the designation
of its imaging centers as IPLs gives it greater operational control than it
would have if its imaging centers were operated under the medical group
model, where InSight would function as a "manager".
On June 18, 1997, in response to the lack of designation for imaging
services, HCFA published proposed regulations which, among other things,
would establish a new category of Medicare provider referred to as an
Independent Diagnostic Treatment Facility ("IDTF"). The proposed IDTF
regulations contemplate an effective date of January 1, 1998, although
InSight's management believes that the effective date could be July 1, 1998.
If these regulations are implemented, it appears that imaging centers will
have the option to participate in the Medicare program as either (i) IDTFs
or (ii) medical groups.
InSight has evaluated the proposed IDTF regulations for the purpose of
assessing their potential impact on InSight's operations. Although InSight
believes that the impact of the IDTF regulations is likely to be positive
overall, InSight had a number of concerns and submitted comments to HCFA
regarding those concerns. InSight currently anticipates converting its
imaging centers to IDTFs once that category is available; however, if some of
the IDTF qualifications and obligations, outlined in the proposed IDTF
regulations are unmodified, InSight believes that IDTFs may be at a
substantial competitive disadvantage with those imaging centers operated as
medical groups. Accordingly, InSight may consider converting some or all of
its existing centers into the medical group model, with InSight functioning
as a "manager" of the radiology group. This conversion will require the
cooperation of the radiology groups associated with InSight's imaging centers.
The U.S. Food and Drug Administration ("FDA") has issued the requisite
premarket approval for all of the MRI, CT and Gamma Knife systems utilized by
InSight. The Company does not believe that any further FDA approval is
required in connection with equipment currently in operation or proposed to
be operated.
The radiologists with whom InSight may enter into agreements to provide
professional services are subject to licensing and related regulations by the
states. As a result, the Company requires its radiologists to have and
maintain appropriate licensure. InSight does not believe that such laws and
regulations will either prohibit or require licensure approval of its
business operations, although no assurances can be made that such laws and
regulations will not be interpreted to extend such prohibitions or
requirements to InSight's operations.
MANAGED CARE
Health Maintenance Organizations ("HMOs") and Preferred Provider
Organizations ("PPOs") attempt to control the cost of health care services.
InSight believes that the development and expansion of HMOs, PPOs and other
managed care organizations will have a negative impact on utilization of
InSight services in certain markets and/or affect the revenue per procedure
which the Company can collect, since they will exert greater control over
patients' access to diagnostic imaging services, the selection of the
provider of such services and the reimbursement thereof. InSight also expects
that the excess capacity of equipment in the United States may negatively
impact operations because of the competition among health care providers for
contracts with all types of managed care organizations. As a result of such
competition, the length of term of any contracts which InSight may obtain and
the payment to the Company for such services may also be negatively impacted.
InSight nonetheless believes that as long as it is able to negotiate provider
agreements with the managed care companies and other payors to provide
productive and cost-efficient services with measurable outcomes, InSight's
business as a whole should not be negatively impacted. See "Customers and
Fees".
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LIABILITY INSURANCE
InSight does not provide medical services, although it has obtained
professional liability insurance as well as general liability insurance. In
addition, the radiologists or other health care professionals with whom the
Company contracts are required by such contracts to carry adequate medical
malpractice insurance. InSight believes that its insurance is adequate for
its business of providing diagnostic imaging, treatment and related
management services.
COMPETITION
The health care industry in general, and the market for diagnostic imaging
services in particular, are highly competitive. InSight's operations must
compete with groups of radiologists, established hospitals and certain other
independent organizations, including equipment manufacturers and leasing
companies, that own and operate imaging equipment. InSight will continue to
encounter substantial competition from hospitals and independent
organizations. Certain hospitals, particularly the larger hospitals, may be
expected to directly acquire and operate imaging and treatment equipment
on-site as part of their overall inpatient servicing capability. In the past,
however, the reluctance of hospitals to purchase imaging and treatment
equipment encouraged the entry of start-up ventures and more established
business operations into the diagnostic and treatment services business. As a
result, there is significant excess capacity in the diagnostic imaging
business in the United States which negatively affects utilization and
reimbursement. Many of these competitors have substantially greater
resources than InSight; however, the Company competes principally on the
basis of its reputation for productive and cost-effective quality services.
CUSTOMERS AND FEES
InSight's revenues are primarily generated from contract services and patient
services. Contract services revenues are generally earned from services
billed to a hospital or other health care provider which include: (i)
fee-for-service arrangements in which revenues are based upon a contractual
rate per procedure, (ii) equipment rental in which revenues are generally
based upon a fixed monthly rental, and (iii) management fees. Contract
services revenues are primarily earned through Mobile Facilities and certain
Fixed Facilities. Patient services revenues are services billed directly to
patients or third party payors (generally managed care organizations and
commercial insurance carriers), and are primarily earned through Centers and
certain Fixed Facilities.
InSight's operations are principally dependent on its ability (either
directly or indirectly through its hospital customers) to attract referrals
from physicians and other health care providers representing a variety of
specialties. The Company's eligibility to provide service in response to a
referral is often dependent on the existence of a contractual arrangement
with the referred patient's insurance carrier (primarily if the insurance is
provided by a managed care organization). Managed care contracting has
become very competitive and reimbursement schedules are nearing Medicare
reimbursement levels. A decline in referrals and/or reimbursement rates would
adversely affect InSight's revenues and profits. See "Managed Care".
InSight's contract services revenues, primarily earned by its Mobile
Facilities, represent approximately 51% of total revenues. Each year
approximately one-quarter to one-third of the contract services agreements
are subject to renewal. It is expected that some high volume customer
accounts will elect not to renew their agreements and instead will purchase
or lease their own diagnostic imaging equipment and some customers may choose
an alternative services provider. In the past where agreements have not been
renewed, the Company has been able to obtain replacement customer accounts;
however, it is not always possible to obtain replacement accounts and some
replacement accounts have been smaller than the lost account. The
non-renewal of a single customer agreement would not have a material impact
on InSight's contract services revenues; however, non-renewal of several
agreements could have a material impact on contract services revenues.
In addition, the Company's contract services revenues with regard to its
Mobile Facilities in certain markets depend in part on some customer accounts
with high volume. If the future reimbursement levels of such customers were
to decline or cease or if such customers were to become financially insolvent
and if such agreements were not replaced with new accounts or with the
expansion of services on existing accounts, InSight's contract services
revenues would be adversely affected.
8
No single source accounts for more than 10% of InSight's revenues. The
Company has six individual contracts with the county of Los Angeles (the
"County") covering six separate sites. In the aggregate, these sites earn
revenues which represent approximately 10% of InSight's annual revenues. From
time to time, the County has experienced financial difficulties. If such
difficulties caused the County to curtail or terminate the Company's
services, the Company's business would be adversely affected.
SUPPLY OF DIAGNOSTIC IMAGING AND GAMMA KNIFE SYSTEMS
InSight continues to evaluate the mix of its MRI equipment in response to
changes in technology and to the surplus capacity in the marketplace. The
overall technological competitiveness of InSight's equipment continues to
improve through upgrades, disposal and/or trade-in of older equipment and the
purchase or execution of leases for new equipment.
Several substantial companies are presently engaged in the manufacture of MRI
(including open MRI), CT and other diagnostic imaging equipment, including GE
Medical Systems, Hitachi Medical Systems, Picker International, Philips Medical
Systems, Siemens Medical Systems, Inc. and Toshiba Medical Systems. InSight
maintains good working relationships with many of the major manufacturers to
better ensure an adequacy of supply as well as access to those types of
diagnostic imaging systems which appear most appropriate for the specific
diagnostic or treatment center to be established. Currently only one company,
Elekta Instruments, Inc., a subsidiary of AB Elekta headquartered in
Stockholm, Sweden ("Elekta"), is engaged in the business of manufacturing the
Gamma Knife.
EMPLOYEES
As of September 15, 1997, InSight had approximately 544 full-time and 80
part-time employees. None of the Company's employees are covered by a
collective bargaining agreement. Management believes its employee relations
to be satisfactory.
ITEM 2. PROPERTIES
The following table includes the primary properties utilized by InSight as of
September 15, 1997:
APPROXIMATE
NAME OF FACILITY SQUARE FEET LOCATION
- ---------------- ----------- --------
OWNED:
Berwyn Magnetic Resonance Center 3,800 Berwyn, Illinois
Northern Indiana Oncology Center 3,500 Valparaiso, Indiana
Garfield Imaging Center 4,500 Monterey Park, California
LAC/USC Imaging Sciences Center 8,500 Los Angeles, California
Diagnostic Outpatient Center 13,800 Hobart, Indiana
Harbor/UCLA Diagnostic Imaging Center 15,000 Torrance, California
LEASED:
InSight Corporate Headquarters 12,300 Newport Beach, California
Maxum Diagnostic Center - Forest Lane 14,100 Dallas, Texas
Maxum Diagnostic Center - Eighth Avenue 10,000 Ft. Worth, Texas
Maxum Diagnostic Center - Preston Road 5,800 Dallas/Plano, Texas
Ocean Medical Imaging Center 8,700 Tom's River, New Jersey
Northwest Magnetic Imaging Center 2,400 Seattle, Washington
Northwest Gamma Knife Center 3,400 Seattle, Washington
Washington Magnetic Resonance Center 4,100 Whittier, California
Open MRI of Hayward 6,400 Hayward, California
Central Maine Imaging Center 7,250 Lewiston, Maine
Training/Applications/Fleet Services 20,000 Winston-Salem, North Carolina
Chattanooga Outpatient Center 14,700 Chattanooga, Tennessee
Broad Street Imaging Center 12,700 Columbus, Ohio
9
ITEM 3. LEGAL PROCEEDINGS
InSight is engaged from time to time in the defense of lawsuits arising out
of the ordinary course and conduct of its business and has insurance policies
covering such potential insurable losses where such coverage is
cost-effective. InSight believes that the outcome of any such lawsuits will
not have a material adverse impact on the Company's business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during the
fourth quarter of fiscal 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
InSight's Common Stock began trading on the national over-the-counter market
and quoted on the NASDAQ Small Cap Market under the symbol "IHSC" on July 17,
1996.
The following table sets forth the high and low prices as reported by NASDAQ
for InSight Common Stock for the quarters indicated:
QUARTER ENDED LOW HIGH
------------------ ----- -----
September 30, 1996 4 3/4 7 5/8
December 31, 1996 4 3/4 7
March 31, 1997 4 1/4 6
June 30, 1997 4 4 3/4
The prices (rounded to the nearest 1/8 or nearest 1/32 where applicable)
represent quotations between dealers without adjustment for mark-up, markdown
or commission, and may not necessarily represent actual transactions.
The Company has never paid a cash dividend on its Common Stock and does not
expect to do so in the foreseeable future. The Company's loan agreements
with its primary lender contain restrictions on its ability to pay dividends
on its Common Stock.
As of September 30, 1997, the Company's records indicate that there were in
excess of 2,500 beneficial holders of the Common Stock and approximately
535 stockholders of record.
The following is a list of securities sold by the Company during the period
covered by this report on Form 10-K which, pursuant to the exemption provided
under Section 4(2) of the Securities Act of 1933, as amended (the "Securities
Act"), were not registered under the Securities Act:
On August 10, 1996, the Company issued to the former holders of IHC Series B
Preferred Stock, in consideration for certain agreements in connection with
the Merger, warrants to purchase an aggregate of 50,000 shares of InSight
Common Stock at an exercise price of $5.64 per share. The warrants are fully
vested and exercisable at any time up to August 9, 2001.
On August 14, 1996, the Company issued to Shattuck Hammond Partners, Inc.
("SHP"), an investment banking firm in which a director of the Company, Grant
R. Chamberlain, is a vice president, a warrant to purchase 35,000 shares of
InSight Common Stock at an exercise price of $5.50 per share. The warrant
was issued as partial consideration for SHP's agreement to provide general
strategic advisory and investment banking services during the 18-month period
commencing July 1, 1996 and ending December 31, 1997. The warrant vests
cumulatively on a monthly basis over the term of such agreement.
10
On March 11, 1997, the Company issued to Anthony J. LeVecchio, a former
director of Maxum, a warrant to purchase 15,000 shares of InSight Common
Stock at an exercise price of $5.50 per share. The warrant was issued in
partial consideration for Mr. LeVecchio's agreement to provide general
strategic and business development activities commencing April 1, 1997, for a
one year period. The warrant vests cumulatively at the rate of 5,000 shares
on the first, second and third anniversary dates of such agreement.
ITEM 6. SELECTED FINANCIAL DATA
On June 26, 1996, pursuant to the Merger Agreement each of MHC and IHC became
a wholly owned subsidiary of InSight. The Merger was accounted for using the
purchase method of accounting in accordance with generally accepted
accounting principles. MHC has been treated as the acquirer for accounting
purposes, based upon relative revenues, book values and other factors. The
selected consolidated financial data presented as of and for the year ended
June 30, 1997, the six months ended June 30, 1996 and 1995 (unaudited), and
for the years ended December 31, 1995, 1994, 1993 and 1992 has been derived
from the Company's audited consolidated financial statements and should be
read in conjunction with such consolidated financial statements and related
notes as of and for the year ended June 30, 1997, the six months ended June
30, 1996 and for the years ended December 31, 1995 and 1994 and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
included elsewhere in this report.
(Amounts in thousands, except shares and per share data)
SIX MONTHS ENDED
YEAR ENDED ----------------------- YEARS ENDED DECEMBER 31,
JUNE 30, JUNE 30, JUNE 30, ----------------------------------------------
1997 1996(1) 1995(1) (4) 1995 (1) 1994 (1) 1993 (1) 1992 (1)
---------- ---------- ----------- ---------- ---------- ---------- ----------
STATEMENT OF OPERATIONS DATA:
Revenues $ 93,063 $ 26,460 $ 24,434 $ 50,609 $ 45,868 $ 45,075 $ 45,135
Costs of operations (2) 80,337 27,420 22,986 48,778 45,439 47,456 45,329
---------- ---------- ----------- ---------- ---------- ---------- ----------
Gross profit (loss) 12,726 (960) 1,448 1,831 429 (2,381) (194)
Corporate operating expenses 7,431 2,127 1,915 3,372 4,040 4,344 6,747
---------- ---------- ----------- ---------- ---------- ---------- ----------
Income (loss) from company operations 5,295 (3,087) (467) (1,541) (3,611) (6,725) (6,941)
Equity in earnings from unconsolidated
partnerships 468 138 136 348 834 685 1,020
---------- ---------- ----------- ---------- ---------- ---------- ----------
Operating income (loss) 5,763 (2,949) (331) (1,193) (2,777) (6,040) (5,921)
Interest expense, net (4,055 ) (1,144) (648) (1,626) (1,206) (1,773) (2,391)
Provision for securities litigation
settlement - - - (1,500) - - -
Gain on sale of partnership interests - - - - 4,957 - -
Provision for income taxes (427 ) (65) - - (160) - -
---------- ---------- ----------- ---------- ---------- ---------- ----------
Income (loss) before extraordinary item 1,281 (4,158) (979) (4,319) 814 (7,813) (8,312)
Extraordinary item - 3,179 - - 3,342 1,036 -
---------- ---------- ----------- ---------- ---------- ---------- ----------
Net income (loss) $ 1,281 $ (979) $ (979) $ (4,319) $ 4,156 $ (6,777) $ (8,312)
---------- ---------- ----------- ---------- ---------- ---------- ----------
---------- ---------- ----------- ---------- ---------- ---------- ----------
INCOME (LOSS) PER COMMON SHARE:
Income (loss) before extraordinary
item (3) $ 0.24 $ (2.99) $ (0.73) $ (3.21) $ 0.58 $ (4.49) $ (4.89)
---------- ---------- ----------- ---------- ---------- ---------- ----------
---------- ---------- ----------- ---------- ---------- ---------- ----------
Net income (loss) (3) $ 0.24 $ (0.70) $ (0.73) $ (3.21) $ 2.96 $ (3.89) $ (4.89)
---------- ---------- ----------- ---------- ---------- ---------- ----------
---------- ---------- ----------- ---------- ---------- ---------- ----------
Weighted average number of common shares
outstanding (3) 5,440,315 1,389,271 1,333,169 1,344,832 1,402,435 1,741,846 1,698,602
AT JUNE 30, AT DECEMBER 31,
---------------------- ----------------------------------------------
1997 1996 1995 (1) 1994 (1) 1993 (1) 1992 (1)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA:
Working capital (deficit) $(5,740 ) $(1,167) $(2,228) $1,587 $(8,594) $(14,607)
Property and equipment, net 34,488 29,852 12,386 5,272 9,791 18,772
Intangible assets 33,272 16,965 4,047 1,194 1,263 2,513
Total assets 98,322 70,386 28,306 22,592 23,566 38,043
Total long-term liabilities 59,205 39,839 19,723 9,575 7,967 8,368
Stockholders' equity (deficit) 6,685 5,404 (4,005) 300 (3,857) 2,502
(1) The selected consolidated financial data represents historical data of
MHC only.
(2) Includes a (net credit) provision for prior restructuring costs of
$(0.5) million and $7.5 million in 1993 and 1992, respectively.
(3) Amounts are computed on a pro forma basis as if the reset of par value
of Maxum Common Stock and related conversion into InSight Common Stock
had occurred on January 1, 1992.
(4) Unaudited.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis is provided to increase understanding
of, and should be read in conjunction with Item 1. "Business", and Item 8.
"Financial Statements and Supplementary Data", included elsewhere in this
report.
ACQUISITIONS
InSight believes a consolidation in the diagnostic imaging industry is
occurring and is necessary in order to provide surviving companies the
opportunity to achieve operating and administrative efficiencies through
consolidation. The strategy of InSight will be focused on five interrelated
initiatives: (i) consolidation of the highly fragmented diagnostic imaging
industry through acquisition of organizations which either strategically fit
into its regional networking strategy or provide significant cost savings;
(ii) development of a radiology co-source product where InSight will provide
management services for radiology departments within hospitals, (iii)
development of regional networks of radiology providers and physicians
designed to provide the highest quality and most cost-effective unit of
diagnostic information to the broadest population in a given market, (iv)
development of a network of open MRI systems and (v) new business initiatives
focused on broadening its range of services to managed care organizations,
hospitals and physician management companies to include radiology management
services; information management services; unbundling of current core
services such as billing and collections, technician training and staffing,
and asset management and continued evaluation of opportunities with emerging
technologies. InSight believes that long-term viability is contingent upon
its ability to successfully participate in this industry consolidation.
InSight views the Merger of MHC and IHC as reflective of this consolidation.
As part of its consolidation strategy, InSight completed three acquisitions
during fiscal 1997 and one in the first quarter of fiscal 1998 as follows:
In September 1996, InSight completed the acquisition of a Fixed Facility in
Hayward, California. The transaction included the purchase of certain
assets, primarily diagnostic equipment. The purchase price of approximately
$2.8 million was financed by GE.
In May 1997, InSight acquired certain assets, primarily Mobile Facilities, in
Maine and New Hampshire, and assumed certain equipment related liabilities.
The purchase price of approximately $6.8 million and an additional $0.4
million for working capital requirements were financed by GE.
In June 1997, InSight completed the acquisition of a Center in Chattanooga,
Tennessee. The transaction included the purchase of certain assets,
primarily diagnostic equipment, and the assumption of certain equipment
related liabilities. The purchase price of approximately $9.0 million was
financed by GE.
In July 1997, InSight completed the acquisition of a Center in Columbus,
Ohio. As part of this transaction, InSight also has a majority ownership in
the development of a new Center in Dublin, Ohio. The transactions included
the purchase of certain assets, primarily diagnostic equipment, and the
assumption of certain equipment related liabilities. The purchase price of
approximately $5.5 million and approximately $0.5 million for the Center
under development were financed by GE.
In July 1997, InSight entered into a definitive agreement to acquire a Center
in Murfreesboro, Tennessee, subject to the satisfaction of certain
conditions. GE has agreed to finance the purchase price of
approximately $2.7 million; however, the Bank Financing may be used to finance
the purchase price.
Upon the consummation of the Bank Financing, which InSight expects to occur
by early November 1997, InSight will have at its disposal an acquisition
facility in the amount of $50 million, which may be increased under certain
circumstances to $75 million. InSight believes this facility will enhance
its ability to participate in the industry consolidation.
12
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
InSight operates in a capital intensive, high fixed cost industry that
requires significant amounts of working capital to fund operations,
particularly the initial start-up and development expenses of new operations
and yet is constantly under external pressure to contain costs and reduce
prices. Revenues and cash flows have been adversely affected by an increased
collection cycle, competitive pressures and major restructurings within the
health care industry. This adverse effect on revenues and cash flow is
expected to continue, especially in the mobile diagnostic imaging business.
Management believes that InSight's long-term viability and success is
contingent upon its ability to successfully execute its five interrelated
strategic initiatives.
InSight continues to pursue acquisition opportunities. InSight believes that
the expansion of its business through acquisitions is a key factor in
achieving and maintaining profitability. Generally, acquisition
opportunities are aimed at increasing revenues and profits, and maximizing
utilization of existing capacity. Incremental operating profit resulting
from future acquisitions will vary depending on geographic location, whether
facilities are Mobile versus Fixed, the range of services provided and the
Company's ability to integrate the acquired businesses into its existing
infrastructure. Since the Merger, InSight has completed four acquisitions
and entered into a definitive agreement with respect to an additional
acquisition, as discussed above.
As noted above (see Item 1. "Business-Recapitalization"), the Company
consummated the Recapitalization on October 14, 1997 pursuant to which (a)
the Company issued to Carlyle 25,000 shares of Series B Preferred Stock
having a liquidation preference of $1,000 per share and warrants to purchase
250,000 shares of InSight Common Stock at the current exercise price of
$10.00 per share, generating net proceeds to the Company (after related
transaction costs of approximately $2.0 million) of approximately $23.0
million; (b) the Company issued to GE 7,000 shares of Series C Preferred
Stock, with a liquidation preference of $1,000 per share, in consideration of
the termination of GE's right to receive supplemental service fee payments
equal to 14% of InSight's pre-tax income, (for which the Company will record
a non-recurring expense of approximately $6.7 million in the second quarter
of fiscal 1998), and agreed to issue to GE an additional 20,953 shares of
Series C Preferred Stock at the Second Closing in exchange for all of GE's
shares of Series A Preferred Stock; and (c) the Company executed a Credit
Agreement with NationsBank which, subject to the satisfaction of certain
customary conditions, is expected to be consummated by early November and
includes (i) a $50 million term loan facility consisting of a $20 million
tranche with increasing amortization over a five year period and a $30
million tranche principally repayable in years 6 and 7, (ii) a $25 million
revolving working capital facility with a five-year maturity, and (iii) a $50
million acquisition facility, which may be increased by up to an additional
$25 million upon the satisfaction of certain conditions, including
commitments from participating lenders. The net proceeds from the Carlyle
investment will be used to refinance a portion of the outstanding GE
indebtedness (approximately $23 million). At the initial funding of the Bank
Financing, all of the term loan facility is expected to be drawn down to
refinance all of the remaining GE indebtedness (approximately $47 million)
and approximately $10 million of the revolving facility is expected to be
drawn down for working capital purposes. If the Bank Financing is not
consummated for any reason, the Company would be required to seek alternate
financing. In such event, there can be no assurance that such financing
would be available on acceptable terms.
InSight's operations are principally dependent on its ability (either
directly or indirectly through its hospital customers) to attract referrals
from physicians and other health care providers representing a variety of
specialties. The Company's eligibility to provide service in response to a
referral is often dependent on the existence of a contractual arrangement
with the referred patient's insurance carrier (primarily if the insurance is
provided by a managed care organization). Managed care contracting has
become very competitive and reimbursement schedules are nearing Medicare
reimbursement levels. A decline in referrals and/or reimbursement rates
would adversely affect the Company's revenues and profits.
In connection with the Merger, certain financial accommodations with MHC's
and IHC's primary creditor, GE, became effective in June 1996. The financial
accommodations with GE have restricted InSight's ability to raise capital,
incur additional debt, enter into additional leases for equipment, complete
acquisitions, or enter into other corporate transactions without first
obtaining a waiver or consent from GE. The GE indebtedness is expected to be
repaid in full from the proceeds of the Carlyle investment and the Bank
Financing. The terms of the Series B Preferred Stock and the Series C
Preferred Stock, as well as the Bank Financing, contain similar restrictions
on InSight's ability to act without first obtaining a waiver or consent from
Carlyle, GE and NationsBank.
13
Working capital decreased to a deficit of approximately $5.7 million at June
30, 1997 from a deficit of approximately $1.2 million at June 30, 1996. This
increase in deficit of approximately $4.5 million is primarily due to the
current portion of additional debt incurred as a result of the Company's
acquisition strategy discussed above and principal payments on long-term
debt, offset by net income before depreciation and amortization. GE loaned
the Company approximately $25.0 million to complete the acquisitions and has
agreed to loan the Company approximately $2.7 million to complete the
acquisition in Murfreesboro, Tennessee discussed above. Notwithstanding the
above, the Company believes that its current cash balances and cash flows
from operations, will be sufficient to finance its current operations through
June 30, 1998.
Cash and cash equivalents increased to approximately $7.1 million at June 30,
1997 from approximately $6.8 million at June 30, 1996. This increase of
approximately $0.3 million resulted primarily from (i) cash provided by
operating activities of approximately $7.3 million and (ii) long-term
borrowings of approximately $33.7 million, offset by (i) the acquisition of
Centers and Mobile Facilities (approximately $18.6 million), (ii) purchases
of property and equipment (approximately $7.1 million), and (iii) payments on
debt and capital lease obligations (approximately $11.0 million).
The Company has committed to purchase, at an aggregate cost of approximately
$4.0 million, three MRI systems for delivery during the quarter ending
December 31, 1998. The Company has obtained commitments to finance the
purchase or lease of such equipment; however, the Bank Financing may be used
to finance the purchase of such equipment. In addition, the Company has
committed to purchase or lease from GE, at an aggregate cost of
approximately $20 million, including siting costs, 20 open MRI systems for
delivery and installation over the next two years. The Company may purchase,
lease or upgrade other MRI systems as opportunities arise to place new
equipment into service when new contract services agreements are signed,
existing agreements are renewed, acquisitions are completed, or new imaging
centers are developed in accordance with the Company's strategic initiatives.
In February 1996, MHC and the other parties in a class action securities
lawsuit reached a settlement. On July 29, 1996, following final court
approval, MHC and the other parties collectively paid to the plaintiffs in
the class action the balance of the agreed upon settlement amount. In
anticipation of this settlement, MHC recorded a charge of $1.5 million in
1995 and as part of the Merger borrowed approximately $1.9 million from GE
to finance the settlement.
RESULTS OF OPERATIONS
BECAUSE THE MERGER WAS ACCOUNTED FOR USING THE PURCHASE METHOD OF ACCOUNTING
AND MHC WAS TREATED AS THE ACQUIROR, THE FOLLOWING DISCUSSION AND ANALYSIS
CONTAINS THE HISTORICAL FINANCIAL DATA OF THE COMPANY (REFLECTING THE
COMBINED OPERATIONS OF IHC AND MHC) FOR THE YEAR ENDED JUNE 30, 1997 AND THE
HISTORICAL FINANCIAL DATA OF MHC ONLY FOR THE SIX MONTHS ENDED JUNE 30, 1996
AND FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994.
YEAR ENDED JUNE 30, 1997 AND SIX MONTHS ENDED JUNE 30, 1996
REVENUES: Revenues increased approximately $66.6 million for the year ended
June 30, 1997, compared to the six months ended June 30, 1996. The increase
in revenues was due primarily to additional IHC revenues as a result of the
Merger (approximately $38.7 million), increases in revenues due to the
acquisitions discussed above (approximately $2.0 million) and an increase in
contract services, patient services and other revenues at MHC (approximately
$25.9 million). The increase of $25.9 million in MHC revenues was primarily
due to a year of results for 1997 compared to the six month period in 1996.
Compared to 1996 on an annualized basis, MHC revenues decreased by
approximately $0.5 million, or approximately 1%.
Contract services revenues increased approximately $27.8 million for the year
ended June 30, 1997, compared to the six months ended June 30, 1996. This
increase was due primarily to additional IHC revenues as a result of the
Merger (approximately $7.8 million), an increase in revenues due to the
acquisitions discussed above (approximately $0.2 million) and an increase in
MHC revenues of approximately $19.8 million. The increase of $19.8 million
was primarily due to a year of results for 1997 compared to a six month
period in 1996. Compared to 1996 on an annualized basis, MHC revenues
decreased approximately $0.2 million, or 0.5%. This decrease was due to
reductions in reimbursement (approximately 6%) from customers, primarily
hospitals, offset by increased utilization (approximately 30%).
14
InSight's contract services revenues, primarily earned by its Mobile
Facilities, represent approximately 51% of total revenues. Each year
approximately one-quarter to one-third of the contract services agreements
are subject to renewal. It is expected that some high volume customer
accounts will elect not to renew their agreements and instead will purchase
or lease their own diagnostic imaging equipment and some customers may choose
an alternative services provider. In the past where agreements have not been
renewed, the Company has been able to obtain replacement customer accounts;
however, it is not always possible to obtain replacement accounts and some
replacement accounts have been smaller than the lost account. The
non-renewal of a single customer agreement would not have a material impact
on InSight's contract services revenues; however, non-renewal of several
agreements could have a material impact on contract services revenues.
In addition, the Company's contract services revenues with regard to its
Mobile Facilities in certain markets depend in part on some customer accounts
with high volume. If the future reimbursement levels of such customers were
to decline or cease or if such customers were to become financially insolvent
and if such agreements were not replaced with new accounts or with the
expansion of services on existing accounts, InSight's contract services
revenues would be adversely affected.
Patient services revenues increased approximately $36.9 million for the year
ended June 30, 1997, compared to the six months ended June 30, 1996. The
increase in revenues was due primarily to additional IHC revenues as a result
of the Merger (approximately $30.5 million), increased revenues due to the
acquisitions discussed above (approximately $1.8 million), and an increase in
MHC revenues of approximately $4.6 million. The increase in MHC revenues of
$4.6 million was primarily due to a year of results for 1997 compared to a
six month period in 1996. Compared to 1996 on an annualized basis, MHC
revenues decreased approximately $1.3 million, or 11%. This decrease was due
to continued declines in reimbursement (approximately 5%) from third party
payors and the closure of a Fixed Facility in June 1996, offset by increased
utilization (approximately 20%).
No single source accounts for more than 10% of InSight's revenues. The
Company has six individual contracts with the county of Los Angeles
("County") covering six separate sites. In the aggregate, these sites earn
revenues which represent approximately 10% of the Company's annual revenues.
From time to time, the County has experienced financial difficulties. If
such difficulties caused the County to curtail or terminate the Company's
services, the Company's business would be adversely affected.
Management believes that any future increases in revenues can only be
achieved by higher utilization and not by increases in procedure prices since
reimbursement is declining; however, excess capacity of diagnostic imaging
equipment, increased competition, and the expansion of managed care may
impact utilization and make it difficult for the Company to achieve revenue
increases in the future, absent the execution of provider agreements with
managed care companies and other payors, and the execution of the Company's
strategic initiatives.
COSTS OF OPERATIONS: Costs of operations increased approximately $52.9
million for the year ended June 30, 1997, compared to the six months ended
June 30, 1996. This increase was due primarily to additional IHC costs as a
result of the Merger (approximately $29.8 million), an increase in costs due
to the acquisitions discussed above (approximately $1.5 million), and an
increase in costs at MHC of approximately $21.6 million. The increase of
$21.6 million at MHC was primarily due to a year of results for 1997 compared
to a six month period in 1996. Compared to 1996 on an annualized basis, MHC
costs decreased approximately $5.8 million, or 11%. This decrease was due to
a reduction in costs of services, provision for doubtful accounts, and
equipment leases and depreciation and amortization.
Costs of services, including the provision for doubtful accounts, increased
approximately $35.6 million for the year ended June 30, 1997, compared to the
six months ended June 30, 1996. The increase in costs was due primarily to
additional IHC costs as a result of the Merger (approximately $20.8
million), an increase in costs due to the acquisitions discussed above
(approximately $1.2 million) and an increase in costs at MHC (approximately
$13.6 million). The increase in costs at MHC was due primarily to a year of
results for 1997 compared to a six month period in 1996. Compared to 1996 on
an annualized basis, MHC costs decreased approximately $2.9 million. This
decrease was due to (i) reduced costs in service supplies and equipment
maintenance and (ii) one time charges in 1996 related to the closure of two
Centers and the early return of four Mobile Facilities.
15
Equipment leases and depreciation and amortization increased approximately
$17.4 million for the year ended June 30, 1997, compared to the six months
ended June 30, 1996. The increase was due primarily to additional IHC costs
as a result of the Merger (approximately $9.2 million), increased costs due
to the acquisitions discussed above (approximately $0.3 million) and an
increase in costs at MHC (approximately $7.9 million). The increase at MHC
of $7.9 million was primarily due to a year of results for 1997 compared to a
six month period in 1996. Compared to 1996 on an annualized basis, MHC costs
decreased approximately $0.8 million. This decrease was due to a write down
of approximately $1.5 million of intangibles in 1996 which did not occur in
1997.
Under the terms of the amended equipment maintenance service agreement with
GE, GE was entitled to receive a supplemental service fee
equal to 14% of pretax income, subject to certain adjustments. During the
year ended June 30, 1997, the Company recorded a provision of approximately
$0.3 million in connection with this agreement. The Company's future
obligations under this agreement were terminated as part of the
Recapitalization. As mentioned above, the Company will record a
non-recurring expense of $6.7 million in the second quarter of fiscal 1998
in connection with the termination of this agreement.
GROSS PROFIT: Gross profit increased approximately $13.7 million during the
year ended June 30, 1997, compared to the six months ended June 30, 1996.
The increase was due primarily to additional gross profit from IHC as a
result of the Merger (approximately $8.9 million), an increase due to the
acquisitions discussed above (approximately $0.5 million), and an increase at
MHC (approximately $4.3 million).
CORPORATE OPERATING EXPENSES: Corporate operating expenses increased
approximately $5.3 million for the year ended June 30, 1997, compared to the
six months ended June 30, 1996. The increase was partially related to
maintaining duplicate staffing during the transition phase of the Merger and
to additional consulting and legal costs associated with the Company's
acquisition activities. The Company has achieved annualized cost savings
(approximately $1.0 million) compared to the historical combined costs of MHC
and IHC, primarily as a result of elimination of duplicate facilities
including corporate headquarters, and synergies in staff and functional areas.
INTEREST EXPENSE, NET: Interest expense, net increased approximately $2.9
million for the year ended June 30, 1997, compared to the six months ended
June 30, 1996. The increase was due primarily to (i) additional debt assumed
as a result of the Merger (approximately $3.3 million) and (ii) additional
debt related to the acquisitions discussed above (approximately $0.3
million), offset by reduced interest as a result of (i) amortization of the
deferred gain on the debt restructure with GE (approximately $1.0
million) and (ii) amortization of long-term debt.
EXTRAORDINARY GAIN ON DEBT EXTINGUISHMENT: In connection with the Merger,
MHC recorded an extraordinary gain on debt extinguishment of approximately
$3.2 million in 1996. There was no similar gain in 1997.
INCOME (LOSS) PER COMMON SHARE: Net income per common share was $0.24 for
the year ended June 30, 1997, compared to a net loss per common share before
extraordinary item of $(2.99) for the six months ended June 30, 1996. The
improvement in income per common share is the result of (i) increased gross
profit, and (ii) an increase in earnings from unconsolidated partnerships,
offset by (i) increased corporate operating expenses, and (ii) increased
interest expense.
SIX MONTHS ENDED JUNE 30, 1996 AND 1995 (UNAUDITED)
REVENUES: Revenues increased $2.0 million, or approximately 8 percent,
during the six months ended June 30, 1996, compared with the same period in
1995. The increase in revenues was due primarily to the acquisition of
certain customer contracts in April 1995, the acquisition of certain Centers
in October 1995 and increases in volumes on certain contracts serviced by
Mobile and Fixed Facilities. These increases were offset by decreases in
reimbursement rates from third party payors.
COSTS OF OPERATIONS: Costs of operations increased $4.4 million, or
approximately 19 percent, during the six months ended June 30, 1996, compared
with the same period in 1995. This increase was primarily due to (i) the
write down of approximately $1.5 million of goodwill and other intangibles
related to two of MHC's Centers; (ii) an increase in cost of services of $2.3
million and (iii) an increase in depreciation of $0.7 million offset by a
decrease in the provision for doubtful accounts of $0.4 million.
16
Costs of services increased $2.3 million during the six months ended June 30,
1996, compared with the same period in 1995. The increase was due primarily
to (i) certain one-time charges relating to operating strategies associated
with the Merger which include provisions for the closure of two Centers, the
write down of a Mobile Facility and the estimated costs and termination fees
for the early return of four Mobile Facilities; (ii) increased costs
associated with the acquisitions discussed above; and (iii) higher costs
associated with the increase in patient services revenues which include
personnel costs, facility costs, service supplies and professional fees.
The provision for doubtful accounts decreased $0.4 million during the six
months ended June 30, 1996, compared with the same period in 1995. This
decrease is primarily attributable to a $0.3 million charge recorded in June
1995. A similar charge was not recorded in 1996.
Depreciation increased $0.7 million during the six months ended June 30,
1996, compared with the same period in 1995. This increase was due primarily
to capital leases entered into, acquisitions completed, and leasehold
improvements incurred at several of MHC's Fixed Facilities subsequent to June
30, 1995.
GROSS PROFIT: Gross profit decreased $2.4 million during the six months
ended June 30, 1996, compared with the same period in 1995. This decrease
was primarily attributable to the increase in costs of services discussed
above.
CORPORATE OPERATING EXPENSES: Corporate operating expenses increased $0.2
million during the six months ended June 30, 1996, compared with the same
period in 1995. This increase was due primarily to a provision in June 1996
of $0.6 million for termination benefits and facility costs in connection
with the reduction in the duplicative administrative infrastructure as a
result of the Merger.
INTEREST EXPENSE, NET: Interest expense, net increased $0.5 million during
the six months ended June 30, 1996, compared with the same period in 1995.
This increase was due primarily to debt financed in 1995 in connection with
acquisitions and the financing of certain operating expenses.
EXTRAORDINARY GAIN ON DEBT EXTINGUISHMENT: In connection with the Merger,
MHC recorded an extinguishment of $9.0 million of long-term obligations owed
to GE in June 1996. The extraordinary gain represents the excess of
the carrying value of the debt obligations settled over the sum of the fair
value of the Maxum Series B Preferred Stock issued in exchange for such debt
extinguishment and the sum of future interest payable on all remaining
obligations owed to GE.
In accordance with the provisions of troubled debt accounting, a portion of
the extraordinary gain, equal to the sum of the current and long-term
portions of future interest payable on all remaining GE debt was
deferred and will be reduced by future interest payments over the terms of
the respective debt instruments.
YEARS ENDED DECEMBER 31, 1995 AND 1994
REVENUES: Revenues increased $4.7 million, or approximately 10%, in 1995
compared to 1994. The increase in revenues was related primarily to
acquisitions. This increase was partially offset by the continued decline in
reimbursement rates and a decrease in other revenues in 1995 compared to
1994.
An increase in fee-for-service revenues of $5.0 million in 1995 compared to
1994 was attributable to: (i) the award of an exclusive capitated managed
care contract in December 1994, under which MHC's fees were paid directly by
the managed care organization and were earned on a per-member-per-month
basis; and (ii) the acquisition of certain customer contracts in the first
half of 1995. Other fee-for-service revenues and equipment rental revenues
(derived primarily from Mobile Facilities) decreased $1.8 million, compared
to 1994, due to expiration of hospital service contracts and third party
equipment leases. Management fees decreased $0.6 million in 1995, compared to
1994, due primarily to the sale or termination of certain partnerships in
late 1994.
Approximately 58% of the $2.4 million increase in patient services revenues
was due to increased patient services revenues associated with acquisitions
during 1995. Approximately 25% of the increase is attributable to a contract
awarded in the third quarter of 1994 to provide radiology and management
services at an outpatient Fixed Facility for a hospital customer. The
remainder of the increase was due primarily to increases in procedure volumes
at MHC's other Centers, offset by continued declines in reimbursement rates.
17
Other revenues decreased during 1995 compared to 1994, due primarily to the
sale of MHC's technical services division in June 1994.
COSTS OF OPERATIONS: Costs of operations increased $3.3 million, or
approximately 7%, in 1995 compared to 1994. Costs of services in 1995 was
reduced by $0.8 million related to sales/use tax refunds. These refunds
represent taxes paid in prior years attributable to certain mobile diagnostic
imaging equipment, and were received due to a determination by the taxing
authority having reached a determination that the mobile equipment was
subject to motor vehicle tax rather than sales/use tax.
Occupancy expense (which includes operating costs of facilities leased or
subcontracted by MHC) increased $0.8 million, or approximately 88%, in 1995
compared to 1994. This increase was due primarily to subcontracting costs
incurred related to the capitated managed care contract that was awarded in
December 1994.
Professional fees increased $0.7 million, or approximately 41%, in 1995
compared to 1994, due primarily to the increase in patient services revenues
and to costs incurred related to the capitated managed care contract
discussed above.
In addition to the net impact of the sales/use tax refund, occupancy expense
and professional fees discussed above, all other components of costs of
services experienced a net increase of $2.2 million in 1995 compared to 1994,
due primarily to the variable costs associated with the increase in revenues
resulting primarily from acquisitions in 1995 discussed above.
The provision for doubtful accounts increased $0.5 million, or approximately
48%, in 1995 compared to 1994, due primarily to the increase in patient
services revenues and a shift in the payor mix in MHC's Centers related to
the penetration of managed care. This change in payor mix had an unfavorable
impact on reimbursement rates realized by the Centers and resulted in an
increase in bad debt expense in 1995 associated with unreimbursed amounts
which were not subsequently collectible from patients.
Depreciation decreased $0.2 million, or approximately 6%, in 1995 compared to
1994. This decrease was due primarily to a purchase and sale- leaseback
transaction (in connection with MHC's settlement with a significant creditor
in June 1994) which resulted in reductions in net book values of certain
Mobile Facilities.
GROSS PROFIT: Gross profit increased $1.4 million in 1995 compared to 1994.
The increase was primarily attributable to higher profit margins from the
absorption of excess capacity associated with acquisitions completed in 1995
and the capitated managed care contract awarded in December 1994.
CORPORATE OPERATING EXPENSES: Corporate operating expenses decreased
approximately $0.7 million, or approximately 17%, in 1995 compared to 1994.
This decrease was due primarily to reductions in legal costs and insurance
premiums.
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIPS: Equity in earnings of
unconsolidated partnerships decreased $0.5 million, or approximately 58%, in
1995 compared to 1994, due to the sale of certain partnerships in late 1994
discussed below.
INTEREST EXPENSE, NET: Interest expense, net increased $0.4 million, or
approximately 35%, in 1995 compared to 1994. This increase was due primarily
to (i) the addition of several capital leases of diagnostic imaging
equipment; (ii) debt obligations incurred as a result of the acquisitions
during 1995; and (iii) interest on operating expenses financed during late
1994 and in 1995.
PROVISION FOR SECURITIES LITIGATION SETTLEMENT: In anticipation of the MHC
settlement of two class-action lawsuits originally filed in 1993, MHC
recorded a charge of $1.5 million in the fourth quarter of 1995.
GAIN ON SALE OF PARTNERSHIP INTERESTS: In December 1994, MHC sold its
interests in three lithotripsy partnerships for approximately $5.0 million in
cash which resulted in a pretax gain of approximately $5.0 million.
EXTRAORDINARY GAIN ON DEBT EXTINGUISHMENTS: During 1994, MHC settled its
outstanding debt and lease obligations owed to a significant creditor and two
smaller creditors which resulted in a net extraordinary gain of approximately
$3.3 million.
18
INFLATION
Inflation in recent years has not had a significant impact on MHC's or IHC's
business, and is not expected to adversely affect the Company in the near
future.
NEW PRONOUNCEMENTS
In fiscal 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123 "Accounting for Stock Based Compensation". As
permitted under the standard, the Company continued to account for employee
stock options in accordance with APB Opinion No. 25 and made necessary pro
forma disclosures mandated by SFAS No. 123. The adoption of this standard
had no impact on the Company's results of operations.
In fiscal 1998, the Company will be required to adopt SFAS No. 129,
"Disclosure of Information about Capital Structure", which continues the
existing requirements to disclose the pertinent rights and privileges of all
securities other than ordinary common stock but expands the number of
companies subject to portions of its requirements. The adoption of this
standard will have no effect on the Company's results of operations.
The Financial Accounting Standards Board ("FASB") has issued SFAS No. 128,
"Earnings per Share ("EPS")". This standard is effective for both interim
and annual reporting periods ending after December 15, 1997. SFAS No. 128
replaces primary EPS with basic EPS and fully diluted EPS with diluted EPS.
Basic EPS is computed by dividing reported earnings by weighted average
shares outstanding. Diluted EPS is computed in the same way as fully diluted
EPS, except that the calculation now uses the average share price for the
reporting period to compute dilution from options under the treasury stock
method. Management believes that adoption of this standard will not have a
significant impact on earnings per share.
In June 1997, the FASB issued SFAS Nos. 130 and 131, "Reporting Comprehensive
Income" and "Disclosures about Segments of an Enterprise and Related
Information." FASB Nos. 130 and 131 are effective for fiscal years beginning
after December 15, 1997, with earlier adoption permitted. The Company
believes that adoption of these standards will not have a material impact on
the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
Index to Consolidated Financial Statements
for the Year Ended June 30, 1997, for
the Six Months Ended June 30,1996 and for the
Years Ended December 31, 1995 and 1994
PAGE NUMBER
-----------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 22
CONSOLIDATED BALANCE SHEETS 23-24
CONSOLIDATED STATEMENTS OF OPERATIONS 25
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 26
CONSOLIDATED STATEMENTS OF CASH FLOWS 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 28-42
SCHEDULE IX - VALUATION AND QUALIFYING ACCOUNTS 49
20
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To InSight Health Services Corp.:
We have audited the accompanying consolidated balance sheets of INSIGHT
HEALTH SERVICES CORP. (a Delaware corporation) and subsidiaries as of June
30, 1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for the year ended June 30, 1997 and for
the six months ended June 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of InSight Health Services
Corp. and subsidiaries as of June 30, 1997 and 1996, and results of their
operations and their cash flows for the year ended June 30, 1997 and for the
six months ended June 30, 1996, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Orange County, California
October 14, 1997
21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Maxum Health Corp.:
We have audited the accompanying consolidated statements of operations,
stockholders' equity (deficit) and cash flows of Maxum Health Corp. and
Subsidiaries (MHC) for each of the two years in the period ended December 31,
1995. Our audits also included the related financial statement schedule of
valuation and qualifying accounts. These financial statements and schedule are
the responsibility of MHC's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of MHC's operations and its cash flows for each
of the two years in the period ended December 31, 1995, in conformity with
generally accepted accounting principles. Also, in our opinion, such financial
statements schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that MHC will
continue as a going concern. As discussed in Note 3 to the financial
statements, MHC is experiencing difficulty in generating sufficient cash flow to
meet its obligations and sustain its operations. These factors raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are described in Notes 1 and 3. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 1, 1996
22
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
June 30, June 30,
1997 1996
------------ -------------
ASSETS
- -------
CURRENT ASSETS:
Cash and cash equivalents $ 7,135 $ 6,864
Trade accounts receivable, net 15,645 12,916
Other receivables, net 358 973
Other current assets 1,554 1,708
--------- ----------
Total current assets 24,692 22,461
--------- ----------
PROPERTY AND EQUIPMENT:
Vehicles 968 978
Land, building and leasehold improvements 9,589 8,602
Computer and office equipment 3,855 3,638
Diagnostic and related equipment 28,193 18,113
Equipment and vehicles under capital leases 8,086 10,479
--------- ----------
50,691 41,810
Less: Accumulated depreciation and amortization 16,203 11,958
--------- ----------
Property and equipment, net 34,488 29,852
--------- ----------
INVESTMENT IN PARTNERSHIPS 402 359
--------- ----------
OTHER ASSETS 5,468 749
--------- ----------
INTANGIBLE ASSETS, net 33,272 16,965
--------- ----------
$ 98,322 $ 70,386
--------- ----------
--------- ----------
The accompanying notes are an integral part of these consolidated balance
sheets.
23
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
June 30, June 30,
1997 1996
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of equipment and other notes $ 11,901 $ 6,585
Current portion of capital lease obligations 3,561 2,638
Accrued equipment related costs 2,882 3,249
Accounts payable and other accrued expenses 8,822 8,328
Accrued payroll and related costs 2,521 1,775
Current portion of deferred gain on debt restructure 745 1,053
---------- ----------
Total current liabilities 30,432 23,628
---------- ----------
LONG-TERM LIABILITIES:
Equipment and other notes, less current portion 54,421 31,653
Capital lease obligations, less current portion 3,312 3,988
Accrued securities litigation settlement - 1,900
Deferred gain on debt restructure, less current portion 728 1,467
Other long-term liabilities 744 831
---------- ----------
Total long-term liabilities 59,205 39,839
---------- ----------
COMMITMENTS (Note 8)
MINORITY INTEREST 2,000 1,515
---------- ----------
STOCKHOLDERS' EQUITY:
Convertible Series A preferred stock, $.001 par value, 3,500,000 shares
authorized; 2,501,760 outstanding at June 30, 1997 and 1996,
respectively, stated at 6,750 6,750
Common stock, $.001 par value, 25,000,000 shares authorized,
2,714,725 and 2,710,240 shares outstanding at June 30, 1997 and 1996,
respectively 3 3
Additional paid-in capital 23,100 23,100
Accumulated deficit (23,168) (24,449)
---------- ----------
Total stockholders' equity 6,685 5,404
---------- ----------
$ 98,322 $ 70,386
---------- ----------
---------- ----------
The accompanying notes are an integral part of these consolidated balance
sheets.
24
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share and per share data)
Six
Year Ended Months Ended Year Ended Year Ended
June 30, June 30, December 31, December 31,
1997 1996 1995 1994
------------ -------------- ------------- --------------
REVENUES:
Contract services $ 47,827 $ 20,045 $ 38,976 $ 36,393
Patient services 42,706 5,853 10,605 8,228
Other 2,530 562 1,028 1,247
----------- ----------- ---------- ----------
Total revenues 93,063 26,460 50,609 45,868
----------- ----------- ---------- ----------
COSTS OF OPERATIONS:
Costs of services 50,564 15,899 28,772 26,067
Provision for doubtful accounts 1,506 617 1,669 1,124
Equipment leases 18,396 6,957 14,464 14,581
Depreciation and amortization 9,871 3,947 3,873 3,667
----------- ----------- ---------- ----------
Total costs of operations 80,337 27,420 48,778 45,439
----------- ----------- ---------- ----------
GROSS PROFIT (LOSS) 12,726 (960) 1,831 429
CORPORATE OPERATING EXPENSES 7,431 2,127 3,372 4,040
----------- ----------- ---------- ----------
INCOME (LOSS) FROM COMPANY OPERATIONS 5,295 (3,087) (1,541) (3,611)
EQUITY IN EARNINGS OF UNCONSOLIDATED PARTNERSHIP 468 138 348 834
----------- ----------- ---------- ----------
OPERATING INCOME (LOSS) 5,763 (2,949) (1,193) (2,777)
OTHER INCOME (EXPENSE):
Interest expense, net (4,055) (1,144) (1,626) (1,206)
Provision for securities litigation settlement - - (1,500) -
Gain on sale of partnership interests - - - 4,957
----------- ----------- ---------- ----------
(4,055) (1,144) (3,126) 3,751
----------- ----------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES 1,708 (4,093) (4,319) 974
PROVISION FOR INCOME TAXES 427 65 - 160
----------- ----------- ---------- ----------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM 1,281 (4,158) (4,319) 814
EXTRAORDINARY ITEM - Net gain on
debt extinguishment - 3,179 - 3,342
----------- ----------- ---------- ----------
NET INCOME (LOSS) $ 1,281 $ (979) $ (4,319) $ 4,156
----------- ----------- ---------- ----------
INCOME (LOSS) PER COMMON SHARE:
Income (loss) before extraordinary item $ 0.24 $ (2.99) $ (3.21) $ 0.58
----------- ----------- ---------- ----------
Net income (loss) $ 0.24 $ (0.70) $ (3.21) $ 2.96
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
Weighted average number of common shares
outstanding 5,440,315 1,389,271 1,344,832 1,402,435
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial
statements.
25
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in thousands, except share data)
Preferred Stock Common Stock
-------------------- ---------------------------------------
Shares Amount Shares Amount Warrant
-------- -------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1993 - $ - 2,949,488 $ 29 $ 7
Stock issued under employee
purchase plan - - 3,927 - -
Surrender of 132,750 shares
of treasury stock in
settlement of stockholder
note receivable - - - - -
Net income - - - - -
--------- --------- -------- ------- --------
BALANCE AT DECEMBER 31, 1994 - - 2,953,415 29 7
Stock issued under employee
purchase plan - - 51,640 1 -
Net loss - - - - -
--------- --------- -------- ------- --------
BALANCE AT DECEMBER 31, 1995 - - 3,005,055 30 7
Issuance of Series A
Preferred Stock and
cancellation of common
stock warrant 1,250,880 3,375 - - (7)
Acquisition of IHC 1,250,880 3,375 1,349,908 1 -
Retirement of MHC's
treasury stock - - - - -
Reset the par value of
InSight common stock
issued in exchange for
MHC'S common stock - - (1,644,723) (28) -
Net loss - - - - -
--------- --------- ---------- ------- --------
BALANCE AT JUNE 30, 1996 2,501,760 6,750 2,710,240 3 -
Stock options exercised - - 4,485 - -
Net income - - - - -
--------- --------- -- -------- ------- --------
BALANCE AT JUNE 30, 1997 2,501,760 $ 6,750 2,714,725 $ 3 $ -
--------- --------- -------- ------- --------
--------- --------- -------- ------- --------
Additional Stockholder
Paid-In Accumulated Note Treasury
Capital Deficit Receivable Stock Total
----------- ---------------- ------------ ----------- ----------
BALANCE AT DECEMBER 31, 1993 $ 19,679 $ (23,307) $ (110) $ (155) $(3,857)
Stock issued under employee
purchase plan 1 - - - 1
Surrender of 132,750 shares
of treasury stock in
settlement of stockholder
note receivable - - 110 (110) -
Net income - 4,156 - - 4,156
--------- --------- -------- ------- --------
BALANCE AT DECEMBER 31, 1994 19,680 (19,151) - (265) 300
Stock issued under employee
purchase plan 13 - - - 14
Net loss - (4,319) - - (4,319)
--------- --------- -------- ------- --------
BALANCE AT DECEMBER 31, 1995 19,693 (23,470) - (265) (4,005)
Issuance of Series A
Preferred Stock and
cancellation of common
stock warrant - - - - 3,368
Acquisition of IHC 3,644 - - - 7,020
Retirement of MHC's
treasury stock (265) - - 265 -
Reset the par value of
InSight common stock
issued in exchange for
MHC'S common stock 28 - - - -
Net loss - (979) - - (979)
--------- --------- -------- ------- --------
BALANCE AT JUNE 30, 1996 23,100 (24,449) - - 5,404
Stock options exercised - - - - -
Net income - 1,281 - - 1,281
--------- --------- -------- ------- --------
BALANCE AT JUNE 30, 1997 $ 23,100 $ (23,168) $ - $ - $ 6,685
--------- --------- -------- -------- --------
--------- --------- -------- -------- --------
26
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Six
Year Ended Months Ended Year Ended Year Ended
June 30, June 30, December 31, December 31,
1997 1996 1995 1994
------------ -------------- ------------- -------------
OPERATING ACTIVITIES:
Net income (loss) $ 1,281 $ (979) $ (4,319) $ 4,156
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 9,871 4,022 4,060 3,913
Amortization of deferred gain on debt restructure (1,047) - - -
Gain on disposal of assets (113) (133) (35) (112)
Provision for securities litigation settlement - - 1,500 -
Gain on sale of partnership interests - - - (4,957)
Operating expenses financed by issuance of debt - 1,015 2,330 2,672
Extraordinary gain on debt extinguishments - (3,179) - (3,342)
Cash provided by (used in) changes in
operating assets and liabilities:
Payments for restructure costs - - - (700)
Receivables (1,664) (174) (524) (38)
Other current assets 157 (851) (110) 782
Accounts payable and other current liabilities (1,143) 975 (1,089) 1,088
--------- --------- ---------- ----------
Net cash provided by operating activities 7,342 696 1,813 3,462
--------- --------- ---------- ----------
INVESTING ACTIVITIES:
Cash acquired in acquisition of IHC - 5,489 - -
Acquisition of Centers and Mobile Facilities (18,566) - (1,855) (510)
Acquisition of customer contracts and intangibles - - (2,108) -
Proceeds from sales of assets 347 369 745 1,358
Proceeds from sale of partnership interests - - - 5,007
Additions to property and equipment (7,102) (960) (548) (349)
(Increase) decrease in other assets (4,937) 195 190 582
--------- --------- ---------- ----------
Net cash provided by (used in) investing activities (30,258) 5,093 (3,576) 6,088
--------- --------- ---------- ----------
FINANCING ACTIVITIES:
Principal payments of debt and capital lease obligations (11,026) (2,302) (6,020) (4,752)
Proceeds from issuance of debt 33,728 1,507 2,689 268
Net repayments on revolving note payable - - - (250)
Other 485 - 14 1
--------- --------- ---------- ----------
Net cash provided by (used in) financing activities 23,187 (795) (3,317) (4,733)
--------- --------- ---------- ----------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS: 271 4,994 (5,080) 4,817
Cash, beginning of period 6,864 1,870 6,950 2,133
--------- --------- ---------- ----------
Cash, end of period $ 7,135 $ 6,864 $ 1,870 $ 6,950
--------- --------- ---------- ----------
--------- --------- ---------- ----------
SUPPLEMENTAL INFORMATION (Note 13)
The accompanying notes are an integral part of these consolidated financial
statements.
27
INSIGHT HEALTH SERVICES CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. MERGER
InSight Health Services Corp. (InSight or the Company) is a Delaware
corporation formed on February 23, 1996 in connection with the Agreement and
Plan of Merger, dated as of February 26, 1996 (Merger Agreement), among
American Health Services Corp., a Delaware corporation (AHS), Maxum Health
Corp., a Delaware corporation (MHC or Maxum), InSight and two wholly owned
subsidiaries of InSight, AHSC Acquisition Company, a Delaware corporation
(AHSC Acquisition), and MXHC Acquisition Company, a Delaware corporation
(MXHC Acquisition). Pursuant to the terms of the Merger Agreement, (i) AHSC
Acquisition merged with and into AHS and MXHC Acquisition merged with and
into Maxum (collectively, the Merger), (ii) each outstanding share of common
stock, par value $.03 per share, of AHS (AHS Common Stock) was converted into
the right to receive one-tenth of a share of common stock, par value $.001
per share, of InSight (InSight Common Stock), (iii) each outstanding share of
Series B Senior Convertible Preferred Stock, par value $.03 per share, of AHS
(AHS Series B Preferred Stock) which was convertible into 100 shares of AHS
Common Stock was converted into the right to receive 10 shares of InSight
Common Stock, (iv) each outstanding share of Series C Preferred Stock, par
value $.03 per share, of AHS (AHS Series C Preferred Stock), which was issued
immediately prior to the consummation of the Merger, was converted into the
right to receive 1.25088 shares of Series A Preferred Stock, par value $.001
per share, of InSight (InSight Series A Preferred Stock), (v) each
outstanding share of common stock, par value $.01 per share, of Maxum (Maxum
Common Stock) was converted into the right to receive .598 of a share of
InSight Common Stock, (vi) each outstanding share of Series B Preferred
Stock, par value $.01 per share, of Maxum (Maxum Series B Preferred Stock),
which was issued immediately prior to the consummation of the Merger, was
converted into the right to receive 83.392 shares of InSight Series A
Preferred Stock, and (vii) each outstanding option, warrant or other right to
purchase AHS Common Stock and Maxum Common Stock was converted into the right
to acquire, on the same terms and conditions, shares of InSight Common Stock,
with the number of shares and exercise price applicable to such option,
warrant or other right adjusted based on the applicable exchange ratio for
the underlying AHS Common Stock or Maxum Common Stock.
Concurrent with the consummation of the Merger, AHS and MHC completed a debt
restructuring with General Electric Company (GE), the primary creditor of MHC
and AHS. This restructuring resulted in the reduction of certain debt and
operating lease obligations and cancellation of certain stock warrants of MHC
and AHS in exchange for, among other things, the issuance to GE, immediately
prior to the consummation of the Merger, of Maxum Series B Preferred Stock
and AHS Series C Preferred Stock. In connection with this restructuring, MHC
recorded the extinguishment of $9.0 million of long-term debt obligations and
an extraordinary gain representing the difference in the carrying value ($9.0
million) of the debt obligations settled over the fair value ($3.4 million)
of the Maxum Series B Preferred Stock issued to GE. In accordance with the
provisions of troubled debt accounting, a portion of the extraordinary gain,
equal to the sum of the current and long-term portions of future interest
payable on all remaining GE debt and capital lease obligations of $1.0
million and $1.5 million, respectively, was deferred and will be reduced by
future interest payments over the terms of the respective debt instruments.
At the effective time of the Merger, MHC Series B Preferred Stock and AHS
Series C Preferred Stock issued to GE was converted into the right to receive
such number of shares of InSight Series A Preferred Stock that is convertible
into such number of shares of InSight Common Stock representing approximately
48% of InSight Common Stock outstanding at the effective time of the Merger
(after giving effect to such conversion). Under an amended equipment
maintenance service agreement, GE will also be entitled to receive certain
supplemental service fee payments based on future pretax income of InSight.
On September 13, 1996, AHS changed its name to InSight Health Corp. (IHC).
The Merger was accounted for using the purchase method of accounting in
accordance with generally accepted accounting principles. MHC is treated as the
acquiror for accounting purposes, based upon the relative revenues, book values
and other factors. The Consolidated Financial Statements presented herein for
the six months ended June 30, 1996 and for the years ended December 31, 1995 and
1994, respectively, represent the operating results of MHC only.
28
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. NATURE OF BUSINESS
The Company provides diagnostic imaging, treatment and related services to
hospitals, physicians and their patients through its imaging network in 26
states throughout the United States, with a substantial presence in
California, primarily Los Angeles County, and northern Texas, primarily the
Dallas/Ft. Worth metroplex. The Company's services are provided through a
network of 35 mobile magnetic resonance imaging (MRI) facilities (Mobile
Facilities), 28 fixed-site MRI facilities (Fixed Facilities), 10
multi-modality imaging centers (Centers), two Leksell Stereotactic Gamma
Unit treatment centers (Gamma Knife), and one radiation oncology center. An
additional radiation oncology center is operated by the Company as a part
of one of its Centers.
b. CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements include the accounts of InSight and
its wholly owned subsidiaries, MHC and IHC (Note 1). The Company's
investment interests in partnerships (the Partnerships) are accounted for
under the equity method of accounting for ownership of 50 percent or less
when the Company does not exercise significant control over the operations
of the Partnership and does not have primary responsibility for the
Partnership's long-term debt. The Company's consolidated financial
statements include two Partnerships which have been accounted for under the
equity method (Note 12).
At June 30, 1997 and 1996, respectively, the Company has consolidated two
50 percent owned Partnerships and one less than 50 percent owned limited
liability company. Since the Company controls the operations of these 50
percent or less owned entities and is primarily responsible for the
associated long-term debt, management believes that consolidation of these
entities is the most meaningful financial statement presentation (Note 12).
Significant intercompany balances have been eliminated.
c. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.
d. REVENUE RECOGNITION
Revenues from contract services (primarily Mobile Facilities) and from
patient services (primarily Centers) are recognized when services are
provided. Patient services revenues are presented net of related
contractual adjustments. Equipment rental revenues, management fees and
other revenues are recognized over the applicable contract period. Revenues
collected in advance are recorded as unearned revenue.
e. CASH EQUIVALENTS
Cash equivalents are generally composed of highly liquid investments with
original maturities of three months or less, such as certificates of
deposit and commercial paper.
f. PROPERTY AND EQUIPMENT
Property and equipment are depreciated and amortized on the straight-line
method using the following estimated useful lives:
Vehicles 3 to 8 years
Buildings 7 to 19 years
Leasehold improvements Term of lease
Computer and office equipment 3 to 5 years
Diagnostic and related equipment 5 to 8 years
Equipment and vehicles under capital leases Term of lease
29
The Company capitalizes expenditures for improvements and major renewals.
Maintenance, repairs and minor replacements are charged to operations as
incurred. When assets are sold or otherwise disposed of, the cost and
related reserves are removed from the accounts and any resulting gain or
loss is included in the results of operations.
g. INTANGIBLE ASSETS
The Company assesses the recoverability of its intangible assets (including
goodwill) by determining whether the intangible asset balance can be
recovered over the remaining amortization period through projected
nondiscounted future cash flows. If projected future cash flows indicate
that the unamortized intangible asset balances will not be recovered, an
adjustment is made to reduce the net intangible asset to an amount
consistent with projected future cash flows discounted at the Company's
incremental borrowing rate. Cash flow projections, although subject to a
degree of uncertainty, are based on trends of historical performance and
management's estimate of future performance, giving consideration to
existing and anticipated competitive and economic conditions.
The Company has classified as goodwill the cost in excess of fair value of
the net assets acquired in purchase transactions. Intangible assets are
amortized on the straight-line basis over the following periods (See Note
6):
Goodwill 6 to 20 years
Non-compete agreements 5 to 7 years
Certificates of need 6 years
h. INCOME TAXES
The Company accounts for income taxes using the liability method in
accordance with the Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes", which requires the asset and liability
method of accounting for income taxes.
i. INCOME (LOSS) PER COMMON SHARE
The number of shares used in computing income (loss) per common share is
equal to the weighted average number of common and common equivalent shares
outstanding during the respective period, adjusted retroactively for the
conversion of Maxum Common Stock into InSight Common Stock as a result of
the Merger. Common stock equivalents relating to options, warrants and
convertible preferred stock are excluded for all periods prior to June 30,
1997 because they are antidilutive.
j. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value of financial instruments are estimated using available market
information and other valuation methodologies. The fair value of the
Company's financial instruments is estimated to approximate the related
book value, unless otherwise indicated.
k. NEW PRONOUNCEMENTS
In fiscal 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123 "Accounting for Stock Based Compensation". As
permitted under the standard, the Company continued to account for employee
stock options in accordance with APB Opinion No. 25 and made necessary pro
forma disclosures mandated by SFAS No. 123. The adoption of this standard
had no impact on the Company's results of operations.
In fiscal 1998, the Company will be required to adopt SFAS No. 129,
"Disclosure of Information about Capital Structure", which continues the
existing requirements to disclose the pertinent rights and privileges of
all securities other than ordinary common stock but expands the number of
companies subject to portions of its requirements. The adoption of this
standard will have no effect on the Company's results of operations.
The Financial Accounting Standards Board (FASB) has issued SFAS No. 128,
"Earnings per Share (EPS)". This standard is effective for both interim
and annual reporting periods ending after December 15, 1997. SFAS No. 128
replaces primary EPS with basic EPS and fully diluted EPS with diluted EPS.
Basic EPS is
30
computed by dividing reported earnings by weighted average shares
outstanding. Diluted EPS is computed in the same way as fully diluted EPS,
except that the calculation now uses the average share price for the
reporting period to compute dilution from options under the treasury stock
method. Management believes that adoption of this standard will not have a
significant impact on earnings per share.
In June 1997, the FASB issued SFAS Nos. 130 and 131, "Reporting
Comprehensive Income" and "Disclosures about Segments of an Enterprise and
Related Information." FASB Nos. 130 and 131 are effective for fiscal years
beginning after December 15, 1997, with earlier adoption permitted. The
Company believes that adoption of these standards will not have a material
impact on the Company.
l. RECLASSIFICATIONS
Reclassifications have been made to certain 1996, 1995 and 1994 amounts to
conform to the 1997 presentation.
3. PRIOR RESTRUCTURE OF MHC'S OPERATIONS AND FINANCIAL OBLIGATIONS
As of December 31, 1995, MHC did not have the resources to support its
existing debt service and lease requirements and an obligation to settle
pending securities litigation. The accompanying 1995 and 1994 financial
statements were prepared on a going concern basis, and accordingly did not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities had
MHC been unable to continue as a going concern. In June 1996, the financial
accommodation transactions with GE were closed and the Merger was consummated
(Note 1).
4. ACQUISITIONS
In June 1996, InSight, MHC and IHC completed the Merger (Note 1). The Merger
was accounted for under the purchase method with MHC being treated as the
acquiror for accounting purposes.
In September 1996, InSight purchased certain assets of a Fixed Facility in
California for approximately $2.8 million in cash.
In May 1997, InSight purchased certain assets, primarily Mobile Facilities in
Maine and New Hampshire. InSight paid approximately $6.8 million in cash and
assumed certain equipment related liabilities of approximately $1.9 million.
In June 1997, InSight purchased certain assets of a Center in Tennessee.
InSight paid approximately $9.0 million in cash and assumed certain equipment
related liabilities of approximately $1.9 million.
In May 1997, the Company entered into a definitive agreement to purchase certain
assets of a Center in Ohio. As part of the definitive agreement, the Company
deposited approximately $5.5 million into an escrow account. At June 30, 1997
this deposit is included in other assets.
31
These acquisitions were accounted for under the purchase method. Accordingly,
the results of related operations have been included in the consolidated
financial statements since the applicable acquisition dates. The pro forma
effects of these acquisitions, as if they had occurred as of January 1, 1996,
are summarized as follows (amounts in thousands):
Six Months
Year Ended Ended
June 30, 1997 June 30, 1996
------------- -------------
(Unaudited)
Revenues $104,370 $50,092
Expenses 102,285 54,286
-------- -------
Income (loss) before extraordinary item 2,085 (4,194)
Extraordinary item - 3,179
-------- -------
Net income (loss) $ 2,085 $(1,015)
-------- -------
-------- -------
Income (loss) per share before extraordinary item $ 0.38 $ (1.55)
-------- -------
-------- -------
Net income (loss) per share $ 0.38 $ (0.37)
-------- -------
-------- -------
The pro forma results for 1997 and 1996 include $0.8 million and $0.7 million of
amortization of intangibles, respectively, and $1.7 million and $0.8 million of
interest expense, respectively, related to these acquisitions. The pro forma
results in 1996 do not include the interest and lease savings resulting from the
Merger.
5. TRADE RECEIVABLES
Trade receivables are comprised of the following (amounts in thousands):
June 30,
------------------
1997 1996
------- -------
Trade receivables $26,271 $23,004
Less: Allowances for doubtful accounts and
contractual adjustments 7,491 7,808
Allowances for professional fees 3,135 2,280
------- -------
Net trade receivables $15,645 $12,916
------- -------
------- -------
Net trade receivables arise from revenue generated by:
Patient services $ 9,199 $ 7,362
Contract services 5,431 4,693
Other 1,015 861
------- -------
Net trade receivables $15,645 $12,916
------- -------
------- -------
Receivables related to patient services revenues are due primarily from
managed care organizations, patients' private insurance companies and
government payors. Receivables arising from contract service revenues are due
primarily from hospitals.
The allowance for doubtful accounts and contractual adjustments include
management's estimate of the amounts expected to be written off on specific
accounts and for write offs on other as yet unidentified accounts included in
accounts receivable. In estimating the write offs and adjustments on specific
accounts, management relies on a combination of in-house analysis and a
review of contractual payment rates from private health insurance programs or
under the federal Medicare program. In estimating the allowance for
unidentified write offs and adjustments, management relies on historical
experience. The amounts the Company will ultimately realize could differ
materially in the near term from the amounts assumed in arriving at the
allowance for doubtful accounts and contractual adjustments in the financial
statements at June 30, 1997.
32
The Company reserves a contractually agreed upon percentage at several of its
Centers, averaging 20 percent of the accounts receivable balance from
patients, for payments to radiologists for interpreting the results of the
diagnostic imaging procedures. Payments to radiologists are only due when
amounts are received. At that time, the balance is transferred from the
allowance account to a professional fees payable account.
6. INTANGIBLE ASSETS
Intangible assets consist of the following (amounts in thousands):
June 30,
------------------
1997 1996
------- -------
Intangible assets $35,290 $17,861
Less: Accumulated amortization 2,018 896
------- -------
$33,272 $16,965
------- -------
------- -------
Goodwill $32,804 $16,382
Non-compete agreements 175 245
Customer service contracts - 113
Certificates of need 125 158
Other 168 67
------- -------
$33,272 $16,965
------- -------
------- -------
In connection with the Company's acquisitions in 1997 and the Merger in 1996
(Note 1), the Company recorded $17.6 million and $13.6 million of intangible
assets, respectively. Projected future cash flows for two of MHC's Centers
at June 30, 1996 indicated that the unamortized goodwill of $1.4 million and
the unamortized deferred organizational costs of $0.1 million related to
these two Centers were not recoverable. Therefore, in accordance with the
Company's policy, the intangible assets related to these Centers were written
down during the six months ended June 30, 1996. Amortization of intangible
assets was $1.4 million, $1.9 million (including the $1.5 million discussed
above), $0.6 million and $0.2 million for the year ended June 30, 1997, for
the six months ended June 30, 1996 and for the years ended December 31, 1995,
and 1994, respectively.
33
7. EQUIPMENT AND OTHER NOTES PAYABLE
Equipment and other notes payable consists of the following (amounts in
thousands):
June 30,
------------------
1997 1996
------- -------
Notes payable to GE, bearing interest at rates
which range from 9.16 percent to 12.5
percent, maturing at various dates through
August 2004. The notes are secured by
substantially all of the Company's assets. $62,329 $36,072
Notes payable to banks and third parties bearing
interest rates which range from 8.13 percent to
11 percent, maturing at various dates through
September 2000. The notes are primarily secured by
certain buildings and diagnostic equipment. 3,993 2,166
------- -------
Total equipment and other notes payable 66,322 38,238
Less: Current portion 11,901 6,585
------- -------
Long-term equipment and other notes payable $54,421 $31,653
------- -------
------- -------
Scheduled maturities of equipment and other notes payable at June 30, 1997,
are as follows (amounts in thousands):
1998 $11,901
1999 13,574
2000 12,472
2001 8,095
2002 6,840
Thereafter 13,440
-------
$66,322
-------
-------
The terms of the notes payable to GE include certain restrictive
covenants which, among others, limit capital expenditures and restrict
payment of dividends. As of June 30, 1997, the Company was in compliance
with these covenants.
Interest paid, including amounts deferred as part of the debt restructuring,
on debt related to GE for the year ended June 30, 1997, for the six
months ended June 30, 1996 and the years ended December 31, 1995 and 1994,
was $4.0 million, $0.8 million, $1.0 million and $0.6 million, respectively.
8. LEASE OBLIGATIONS AND COMMITMENTS
The Company is leasing diagnostic equipment, certain other equipment and its
office facilities under various capital and operating leases. Future minimum
scheduled rental payments required under these noncancelable leases at June
30, 1997, are as follows (amounts in thousands):
Capital Operating
------- ---------
1998 $4,107 $16,148
1999 2,258 11,282
2000 1,256 5,831
2001 98 3,346
2002 - 1,230
Thereafter - 2,062
------- ---------
Total minimum lease payments 7,719 $39,899
---------
---------
Less: Amounts representing interest 846
-------
Present value of capital lease
obligations 6,873
Less: Current portion 3,561
-------
Long term capital lease obligations $3,312
-------
-------
As of June 30, 1997, a substantial amount of equipment leased by the Company
is subject to contingent rental adjustments dependent on certain operational
factors through 1999. The Company's future operating and capital lease
obligations to GE were approximately $24.8 million and $2.6 million,
respectively.
34
Rental expense for diagnostic equipment and other equipment for the year
ended June 30, 1997, for the six months ended June 30, 1996 and for the years
ended December 31, 1995 and 1994, was $18.3 million, $7.0 million, $14.5
million and $14.6 million, respectively. These amounts include contingent
rental expense of $0.3 million, $0.2 million, $0.5 million and $0.8 million
for the year ended June 30, 1997, for the six months ended June 30, 1996 and
for the years ended December 31, 1995 and 1994, respectively.
The Company occupies office facilities under lease agreements expiring
through June 2007. Rental expense for these facilities for the year ended
June 30, 1997, for the six months ended June 30, 1996 and for the years ended
December 31, 1995 and 1994, was $1.9 million, $0.3 million, $0.6 million and
$0.6 million, respectively.
Under the terms of the amended equipment service agreement with GE (Note 1),
GE is entitled to receive a supplemental service fee equal to 14% of pretax
income, subject to certain adjustments. During the year ended June 30, 1997
the Company recorded a provision of approximately $0.3 million in connection
with this agreement.
InSight is engaged, from time to time, in the defense of lawsuits arising out
of the ordinary course and conduct of its business and has insurance policies
covering such potential insurable losses where such coverage is
cost-effective. InSight believes that the outcome of any such lawsuits will
not have a material adverse impact on InSight's business.
9. CAPITAL STOCK
WARRANTS - During 1997, InSight issued warrants to purchase 50,000 shares of
its common stock at an exercise price of $5.64 per share to the previous
preferred stockholders of IHC. InSight also issued a warrant to purchase
35,000 shares of its common stock at an exercise price of $5.50 per share to
an investment banking firm. InSight also issued a warrant to purchase 15,000
shares of its common stock at an exercise price of $5.50 per share to a
consultant. In connection with the Merger, InSight assumed a warrant to
purchase 20,000 shares of its common stock at an exercise price of $2.50 per
share issued to the estate of Cal Kovens, a former director of IHC.
STOCK OPTIONS - The Company has two stock option plans which provide for the
granting of incentive and nonstatutory stock options to key employees,
independent contractors and non-employee directors. Incentive stock options
must have an exercise price of at least the fair market value of its common
stock on the grant date. Options become vested cumulatively over various
periods up to four years from the grant date, are exercisable in whole or in
installments, and expire five or ten years from the grant date. In addition,
MHC has a stock option plan and IHC has two stock option plans which provided
for the granting of incentive or nonstatutory stock options to key employees,
non-employee directors and independent contractors. Pursuant to the Merger,
the Company assumed all of MHC's and IHC's outstanding options at June 26,
1996. No shares are available for future grants under the MHC and IHC plans.
The Company accounts for these plans under APB Opinion No. 25, under which no
compensation cost has been recognized. SFAS No. 123 was issued in 1995 and,
if fully adopted, changes the methods for recognition of cost on plans
similar to those of the Company. Adoption of SFAS No. 123 is optional,
however pro forma disclosures as if the Company had adopted the cost
recognition method are required. Had compensation cost for stock options
awarded under this plan been determined consistent with SFAS No. 123, the
Company's net income and earnings per share would have reflected the
following pro forma amounts:
June 30,
-------------------------
1997 1996
---------- ------------
Net Income (Loss): As Reported $1,281,000 $ (979,000)
Pro Forma 966,000 (1,055,000)
Primary EPS: As Reported 0.24 (0.70)
Pro Forma 0.18 (0.76)
35
The Company may grant options for up to 446,433 shares under one plan and
158,000 shares under the second plan. A summary of the status of the
Company's two stock option plans at June 30, 1997 and 1996 and changes during
the periods then ended is presented below:
Year Ended Six Months Ended
June 30, 1997 June 30, 1996
------------------------- --------------------------
Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price
------ ---------------- ------ -----------------
Outstanding at beginning of period 369,918 $ 2.37 204,068 $3.04
Granted 233,000 6.19 195,850 S3.23
Exercised 4,485 2.50 30,000 0.25
Forfeited - - - -
Expired 25,000 13.85 - -
------- ------ ------- -----
Outstanding at end of period 573,433 $ 3.98 369,918 $3.15
------- ------ ------- -----
------- ------ ------- -----
Exercisable at end of period 296,416 $ 2.12 263,378 $4.25
------- ------ ------- -----
------- ------ ------- -----
Weighted average fair value of
options granted $ 5.04 $2.61
272,230 of the options outstanding at June 30, 1997 have exercise prices of
$0.10 to $2.50, a weighted average exercise price of $0.86 and a weighted
average remaining contractual life of 6.35 years. 255,430 of these options
are exercisable. 58,000 of the options outstanding at June 30, 1997 have
exercise prices of $3.75 to $5.50, a weighted average exercise price of $5.25
and a weighted average remaining contractual life of 8.98 years. 16,200 of
these options are exercisable. 223,000 of the options outstanding at June
30, 1997 have exercise prices of $6.25 to $7.00, a weighted average exercise
price of $6.30 and a weighted average remaining contractual life of 9.25
years. 4,583 of these options are exercisable. 20,203 of the options
outstanding at June 30, 1997 have exercise prices of $15.64 to $16.20, a
weighted average exercise price of $15.80 and a weighted average remaining
contractual life of 4.19 years. 20,203 of these options are exercisable.
The fair value of each option grant is estimated on the date of grant using
the Black Scholles pricing model with the following assumptions used for the
grants in fiscal periods 1997 and 1996; weighted average risk-free interest
rate of 7.02 percent and 6.75 percent; expected dividend yields of 0.00
percent; and a weighted average contractual life of 8.08 and 9.29 years,
respectively.
10. INCOME TAXES
The provision for income taxes for the year ended June 30, 1997 was computed
using effective tax rates calculated as follows:
Federal statutory tax rate 34.0%
State income taxes, net of federal benefit 1.2
Permanent items, including goodwill, non-deductible
merger costs 41.8
Utilization of deferred tax assets (52.0)
-----
Net effective tax rate 25.0%
-----
-----
36
The provision for income taxes includes income taxes currently payable and those
deferred because of temporary differences between the financial statements and
tax bases of assets and liabilities. The provision for income taxes for the
year ended June 30, 1997 consisted of the following (amounts in thousands):
Current provision
Federal $ 1,268
State 47
--------
1,315
--------
Deferred taxes arising from temporary differences:
State income taxes (31)
Accrued expenses (629)
Deferred gain on debt restructure (368)
Reserves 31
Other 109
--------
(888)
--------
Total provision $ 427
--------
--------
The components of the Company's deferred tax asset as of June 30, 1997 and 1996,
respectively, which arise due to timing differences between financial and tax
reporting and net operating loss (NOL) carryforwards are as follows:
June 30,
-----------------------
1997 1996
---------- ----------
Reserves $ 1,714 $ 1,683
Accrued expenses
(not currently deductible) 604 1,233
Deferred gain on debt restructure 519 887
Depreciation and amortization (139) 77
Other 550 157
NOL carryforwards 15,748 15,601
Valuation allowances (18,996) (19,638)
--------- ----------
$ - $ -
--------- ----------
--------- ----------
As of June 30, 1997, the Company had NOL carryforwards of approximately $38.5
million, expiring in 2004 through 2010. As a result of the Merger, there will
be a substantial limitation on the use of these NOL carryforwards.
A valuation allowance is provided against the deferred tax asset when it is more
likely than not that the deferred tax asset will not be realized. The Company
has established a valuation allowance for the deferred tax allowance for the
deferred tax asset as, in management's best estimate, it is not likely to be
realized in the near term.
11. RETIREMENT SAVINGS PLANS
The Company has a 401(k) profit sharing plan (Company Plan), which is available
to all eligible employees, pursuant to which the Company matches a percentage of
employee contributions to the Company Plan. Company contributions of $335,000
were made for the year ended June 30, 1997.
The Company, through MHC, had a 401(k) profit sharing plan (MHC Plan) for all
MHC employees, pursuant to which MHC matched a percentage of employee
contributions to the Plan and made additional contributions on behalf of the
employees at the discretion of its Board of Directors. Contributions of
$50,000, $100,000 and $62,000 were made during the six months ended June 30,
1996 and the years ended December 31, 1995 and 1994, respectively. MHC
contributions of $12,000 in 1994 were funded with forfeitures.
The Company, through IHC, had a 401(k) profit sharing plan (IHC Plan) for all
IHC employees, pursuant to which IHC matched a percentage of employee
contributions to the IHC Plan. In 1997, the Company combined the MHC Plan and
the IHC Plan into the Company Plan.
37
12. INVESTMENTS IN AND TRANSACTIONS WITH PARTNERSHIPS
The Company, through MHC, has direct ownership in two Partnerships at June 30,
1997, both of which operate Centers. In June 1996, the MHC closed one of the
Centers and is currently in the process of dissolving the Partnership. MHC owns
43.75% and 50% of these Partnerships, serves as the managing general partner and
provides certain management services under agreements expiring in 2007. These
Partnerships are accounted for under the equity method since the Company does
not exercise significant control over the operations of these Partnerships or
does not have primary responsibility for the Partnership's long-term debt. Set
forth below is certain financial data of these Partnerships (amounts in
thousands):
June 30,
----------------------------
1997 1996
---------- ----------
Combined Financial Position:
Current assets:
Cash $ 444 $ 549
Trade receivables, less allowances 729 721
Other 21 31
Property and equipment, net 143 442
---------- ----------
Total assets 1,337 1,743
Current liabilities (141) (358)
Due to MHC (49) (269)
Long-term liabilities (40) (226)
---------- ----------
Net assets $ 1,107 $ 890
---------- ----------
---------- ----------
Set forth below are the combined operating results of the Partnerships and the
Company's equity in earnings of the Partnerships (amounts in thousands):
Six
Year Ended Months Ended Years Ended
June 30, June 30, December 31,
------------------------
1997 1996 1995 1994
---------- ------------ ---------- ----------
Operating Results:
Net revenues $ 4,353 $ 2,346 $ 4,455 $ 13,456
Expenses 3,284 2,002 3,636 9,217
--------- --------- -------- ---------
Net income $ 1,069 $ 344 $ 819 $ 4,239
--------- --------- -------- ---------
--------- --------- -------- ---------
Equity in Earnings:
Share of net income of
Partnerships $ 468 $ 138 $ 348 $ 876
Minority interest - - - (42)
--------- --------- -------- ---------
Equity in earnings of Partnerships $ 468 $ 138 $ 348 $ 834
--------- --------- -------- ---------
--------- --------- -------- ---------
REVENUES OF THE PARTNERSHIPS are recognized when services are provided to
patients at established billing rates or at the amount realizable under
agreements with third party payors, with the provision for contractual
adjustments deducted to report net patient services revenues. The Partnerships'
patient receivables are generally reimbursed by managed care organizations,
and/or patient's private insurance companies, with the remainder of the patient
receivables reimbursed by health care plans and government payors.
38
LEASE COMMITMENTS OF THE PARTNERSHIPS exist under various operating leases for
equipment and office space. Future minimum lease payments for the Partnerships'
noncancelable leases as of June 30, 1997, are as follows (amounts in
thousands):
OPERATING
---------
1998 $ 570
1999 142
------
$ 712
------
------
The Company, through IHC, has direct ownership in two Partnerships and one
limited liability company, all of which operate Centers. IHC owns 50% of each of
the Partnerships and 35% of the limited liability company. Since the Company
controls the operations and is primarily responsible for the associated
long-term debt, the Centers have been included in the Company's consolidated
balance sheet at June 30, 1997 and 1996. Set forth below is the summarized
combined financial data of the Company's 50% or less owned and controlled
entities which are consolidated (amounts in thousands):
Year Ended
June 30,
1997
----------
Condensed Combined Statement
of Operations Data:
Net revenues $ 7,106
Expenses 5,151
Provision for center profit distribution 1,019
--------
Net income $ 936
--------
--------
June 30,
-----------------------
1997 1996
----------- ----------
Condensed Combined Balance Sheet Data:
Current assets $ 2,596 $ 2,327
Total assets 4,288 3,955
Current liabilities 727 1,019
Long-term debt 424 416
Minority interest equity 1,702 1,391
In December 1994, MHC sold the common stock of three wholly owned subsidiaries,
whose primary operations were equity interests of approximately 20% in each of
three Partnerships that provided lithotripsy services, for approximately $5.0
million in cash. MHC's investment in and share of earnings of these
Partnerships had been reported in MHC's financial statements using the equity
method of accounting. This transaction resulted in a pretax gain of
approximately $5.0 million in 1994. In addition, two other Partnerships which
provided services through mobile MRI and CT facilities were terminated in 1994.
MHC leased equipment to certain Partnerships under direct financing leases and
operating leases, and arranged for equipment maintenance services. In
connection with providing these and other services, MHC received management fees
related to certain Partnerships. Revenues related to these Partnership
activities included in MHC's financial statements for the year ended December
31, 1994 were $1.3 million. Substantially all of these revenues relate to
Partnerships that were sold or terminated in 1994.
At June 30, 1996, the Company had a receivable of $0.3 million related to
certain lease and operating expenses of the two existing Partnerships that are
accounted for under the equity method of accounting.
39
13. SUPPLEMENTAL CASH FLOW INFORMATION
The following is provided as supplemental information to the consolidated
statements of cash flows (amounts in thousands):
Six Years Ended
Year Ended Months Ended December 31,
June 30, June 30, ------------------------
1997 1996 1995 1994
---------- -------------- ---------- ----------
Interest paid $ 5,114 $ 1,011 $ 1,411 $ 879
Equipment additions under capital leases 1,779 238 8,117 2,779
Prepaid insurance premiums financed - 208 555 430
Debt and accrued interest extinguished with issuance of
preferred stock - (9,066) - -
Deferred and accrued interest gain on debt restructure - 2,519 - -
Preferred stock issued - 3,375 - -
Cancellation of common stock warrant - (7) - -
14. SUBSEQUENT EVENT
On October 14, 1997, InSight consummated a recapitalization
(Recapitalization) pursuant to which (a) certain investors affiliated with TC
Group, LLC and its affiliates (collectively, Carlyle), a private merchant
bank headquartered in Washington, D.C., made a cash investment of $25 million
in the Company and received therefor (i) 25,000 shares of newly issued
Convertible Preferred Stock, Series B, par value $0.001 per share (Series B
Preferred Stock), initially convertible, at the option of the holders
thereof, in the aggregate into 2,985,075 shares of common stock, and (ii)
warrants (Carlyle Warrants) to purchase up to 250,000 shares of common stock
at the current exercise price of $10.00 per share; (b) General Electric
Company (GE) (i) surrendered its rights under the amended equipment service
agreement to receive supplemental service fee payments equal to 14% of pretax
income (see Note 8, above) in exchange for (i) the issuance of 7,000 shares
of newly issued Convertible Preferred Stock, Series C, par value $0.001 per
share (Series C Preferred Stock) initially convertible, at the option of the
holders thereof, in the aggregate into 835,821 shares of common stock, and
(ii) warrants (the GE Warrants) to purchase up to 250,000 shares of common
stock at the current exercise price of $10.00 per share, (for which the
Company will record a non-recurring expense of approximately $6.7 million in
the second quarter of fiscal 1998), and (ii) agreed to exchange all of its
InSight Series A Preferred Stock, on the business day (Second Closing) after
all waiting periods with respect to GE's filing under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended, have expired or been
terminated, for an additional 20,953 shares of Series C Preferred Stock,
initially convertible, at the option of the holders thereof, in the aggregate
into 2,501,760 shares of common stock; and (c) the Company executed a Credit
Agreement with NationsBank, N.A. pursuant to which NationsBank, as agent,
committed to provide, subject to the satisfaction of customary conditions, a
total of $125 million in senior secured credit, including (i) a $50 million
term loan facility consisting of a $20 million tranche with increasing
amortization over a five year period and a $30 million tranche principally
repayable in years 6 and 7, (ii) a $25 million revolving working capital
facility with a five-year maturity, and (iii) a $50 million acquisition
facility, which may be increased by up to an additional $25 million upon the
satisfaction of certain conditions, including commitments from participating
lenders (Bank Financing).
The terms of the Series B Preferred Stock and the Series C Preferred Stock
(collectively, Preferred Stock) are substantially the same. The Preferred
Stock has a liquidation preference of $1,000 per share. It will participate
in any dividends paid with respect to the common stock. There is no
mandatory or optional redemption provision for the Preferred Stock. The
Series B Preferred Stock is initially convertible, at the option of the
holders thereof, into 2,985,075 shares of common stock, and the Series C
Preferred Stock will, as of the Second Closing, be initially convertible, at
the option of the holders thereof, into 3,337,581 shares of common stock, in
each case at an initial conversion price of $8.375 per share.
For so long as Carlyle and its affiliates own at least 33% of the Series B
Preferred Stock or GE and its affiliates own at least 33% of the Series C
Preferred Stock, respectively, the approval of at least 67% of the holders of
such series of Preferred Stock is required before the Company may take
certain actions including, but not limited to, amending its certificate of
incorporation or bylaws, changing the number of directors or the manner in
which directors are selected, incurring indebtedness in excess of $15 million
in any fiscal year, issuing certain equity securities below the then current
market price or the then applicable conversion price, acquiring equity
interests or assets of entities for consideration equal to or greater than
$15 million, and engaging in
40
mergers for consideration equal to or greater than $15 million. The Preferred
Stock will vote with the common stock on an as-if-converted basis on all matters
except the election of directors, subject to an aggregate maximum Preferred
Stock percentage of 37% of all votes entitled to be cast on such matters.
Assuming the conversion of all of the Series B Preferred Stock into common stock
and the exercise of all of the Carlyle Warrants, Carlyle would own approximately
31% of the common stock of the Company, on a fully diluted basis. Assuming the
conversion of all of the Series C Preferred Stock after the Second Closing and
the exercise of the GE Warrants, GE would own approximately 34% of the common
stock of the Company, on a fully diluted basis.
Pursuant to the terms of the Recapitalization, the number of directors
comprising the Company's Board of Directors (the Board) is currently fixed at
nine. Six directors (Common Stock Directors) are to be elected by the common
stockholders, one of whom (Joint Director) is to be proposed by Carlyle and
GE and approved by a majority of the Board in its sole discretion. Of the
three remaining directors (Preferred Stock Directors), two are to be elected
by the holders of the Series B Preferred Stock and one is to be elected by
the holders of the Series C Preferred Stock, in each case acting by written
consent and without a meeting of the common stockholders. As long as Carlyle
and certain affiliates thereof own an aggregate of at least 50% of the Series
B Preferred Stock, the holders of the Series B Preferred Stock will have the
right to elect two Preferred Stock Directors and as long as Carlyle and
certain affiliates thereof own an aggregate of at least 25% of such stock,
such holders will have the right to elect one Preferred Stock Director. As
long as GE and its affiliates own an aggregate of at least 25% of the Series
C Preferred Stock it will have the right to elect one Preferred Stock
Director. If any such ownership percentage falls below
the applicable threshold, the Preferred Stock Director(s) formerly entitled
to be elected by Carlyle or GE, as the case may be, will thereafter be
elected by the common stockholders.
At any time after the first anniversary of the initial funding of the Bank
Financing, all of the Series B Preferred Stock and the Series C Preferred
Stock may be converted into a newly created Convertible Preferred Stock,
Series D, par value $0.001 per share (Series D Preferred Stock). The Series
D Preferred Stock allows the number of directors to be automatically
increased to a number which would permit each of Carlyle and GE, by filling
the newly created vacancies, to achieve representation on the Board
proportionate to their respective common stock ownership percentages on an
as-if-converted basis but would limit such representation to less than two
thirds of the Board of Directors for a certain period of time. The Series D
Preferred Stock has a liquidation preference of $0.001 per share but no
mandatory or optional redemption provision. It will participate in any
dividends paid with respect to the common stock and will be convertible into
6,322,660 shares of common stock. Presently, the Board consists of seven
directors, five of whom are Common Stock Directors and two of whom are
Preferred Stock Directors. GE intends to wait until the Second Closing to
elect its Preferred Stock Director. The vacancy created for the Joint
Director has not yet been filled.
Holders of the Preferred Stock also have a right of first offer with respect
to future sales in certain transactions or proposed transactions not
involving a public offering by the Company of its common stock or securities
convertible into common stock. Holders of the Preferred Stock are also
entitled to certain demand and "piggyback" registration rights.
41
Set forth below is an unaudited pro forma condensed consolidated balance
sheet as of June 30, 1997, as if the transaction described above had occurred
on June 30, 1997 (amounts in thousands):
Pro Forma
-----------------------------
As Reported Adjustments Total
------------ ------------- -------------
(unaudited)
Current assets $ 24,692 $ 1,477 $ 26,169
Property and equipment, net 34,488 - 34,488
Investment in partnerships 402 - 402
Other assets 5,468 3,100 8,568
Intangible assets 33,272 - 33,272
--------- ----------- ----------
$ 98,322 $ 4,577 $ 102,899
--------- ----------- ----------
--------- ----------- ----------
Current liabilities $ 30,432 $ (10,054) $ 20,378
Long-term liabilities 59,205 (9,276) 49,929
Minority interest 2,000 - 2,000
Stockholders' equity 6,685 23,907 30,592
--------- ----------- ----------
$ 98,322 $ 4,577 $ 102,899
--------- ----------- ----------
--------- ----------- ----------
The unaudited pro forma condensed consolidated balance sheet as of June 30,
1997 gives effect to the issuance of $25 million of Series B Preferred Stock
and the draw down of the $50 million term loan Bank Financing, which was used
to repay approximately $70 million in outstanding notes payable and to pay
approximately $5 million in transaction costs.
42
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be included in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission in connection with the Company's next Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be included in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission in connection with the Company's next Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be included in the Company's
definitive proxy statement, which will be filed with the Securities and
Exchange Commission in connection with the Company's next Annual Meeting of
Stockholders, and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be included in the Company's
definitive proxy statement, which will be filed with the Securities and
Exchange Commission in connection with the Company's next Annual Meeting of
Stockholders, and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
ITEM 14 (a) (1). FINANCIAL STATEMENTS
Included in Part II of this report:
Report of Independent Public Accountants
Report of Independent Public Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
ITEM 14 (a) (2). FINANCIAL STATEMENT SCHEDULES
Report of Independent Public Accountants
Schedule IX - Valuation and Qualifying Accounts
All other schedules have been omitted because they are either not required or
not applicable, or the information is presented in the consolidated
financial statements or notes thereto.
ITEM 14 (a) (3). EXHIBITS
EXHIBIT NUMBER DESCRIPTION AND REFERENCES
*2.1 Agreement and Plan of Merger dated as of February 26, 1996, by
and among InSight, AHS, AHSC Acquisition Company, MHC and MXHC
Acquisition Company, previously filed and incorporated herein
by reference from the Company's Registration Statement on Form
S-4 (Registration No. 333-02935), filed April 29, 1996.
*2.2 Asset Purchase and Liabilities Assumption Agreement dated as of
January 3, 1997, by and among InSight Health Corp., Mobile
Imaging Consortium, Limited Partnership and Mobile Imaging
Consortium-New Hampshire, previously filed and incorporated
herein by reference from the Company's Current Report on Form
8-K, filed June 16, 1997.
*2.3 Amendment No. 1 to Asset Purchase and Liabilities Assumption
Agreement dated as of May 30, 1997, by and among InSight Health
Corp., Mobile Imaging Consortium, Limited Partnership and
Mobile Imaging Consortium-New Hampshire, previously filed
and incorporated herein by reference from the Company's
Current Report on Form 8-K, filed June 16, 1997.
43
*2.4 Asset Purchase and Liabilities Assumption Agreement dated as of
June 20, 1997, by and between InSight Health Corp. and Desmond
L. Fischer, M.D. (d/b/a Chattanooga Outpatient Center),
previously filed and incorporated herein by reference from the
Company's Current Report on Form 8-K, filed July 14, 1997.
*3.1 Certificate of Incorporation of InSight, previously filed and
incorporated herein by reference from the Company's
Registration Statement on Form S-4 (Registration No.
333-02935), filed April 29, 1996.
3.2 Certificate of Designation, Preferences and Rights of
Convertible Preferred Stock, Series B, of InSight, filed
herewith.
3.3 Certificate of Designation, Preferences and Rights of
Convertible Preferred Stock, Series C, of InSight, filed
herewith.
3.4 Certificate of Designation, Preferences and Rights of
Convertible Preferred Stock, Series D, of InSight, filed
herewith.
3.5 Amended and Restated Bylaws of InSight, filed herewith.
*10.1 Master Debt Restructuring Agreement by and among General
Electric Company acting through GE Medical Systems, General
Electric Capital Corporation, InSight, AHS and MHC (without
schedules and exhibits) previously filed and incorporated
herein by reference from the Company's Registration Statement
on Form S-4 (Registration No. 333-02935), filed April 29, 1996.
*10.2 Registration Rights Agreement by and between General Electric
Company acting through GE Medical Systems and InSight,
previously filed and incorporated herein by reference from the
Company's Registration Statement on Form S-4 (Registration No.
333-02935), filed April 29, 1996.
*10.3 Master Service Agreement Addendum by and among General Electric
Company acting through GE Medical Systems, InSight, AHS and
MHC, previously filed and incorporated herein by reference from
the Company's Registration Statement on Form S-4 (Registration
No. 333-02935), filed April 29, 1996.
*10.4 InSight's 1996 Directors' Stock Option Plan, previously filed
and incorporated herein by reference from the Company's
Registration Statement on Form S-4 (Registration No.
333-02935), filed April 29, 1996.
*10.5 InSight's 1996 Employee Stock Option Plan, previously filed and
incorporated herein by reference from the Company's
Registration Statement on Form S-4 (Registration No.
333-02935), filed April 29, 1996.
*10.6 Form of Indemnification Agreement between InSight and each of
its directors and executive officers, previously filed and
incorporated herein by reference from the Company's
Registration Statement on Form S-4 (Registration Statement No.
333-02935), filed April 29, 1996.
*10.8 Agreements and form of warrants with holders of Series B
Preferred Stock of AHS, previously filed and incorporated
herein by reference from the Company's Registration Statement
on Form S-4 (Registration No. 333-02935), filed April 29, 1996.
*10.9 AHS 1987 Stock Option Plan, previously filed and incorporated
herein by reference from Post-Effective Amendment No. 4 on Form
S-1 to AHS's Registration Statement (Registration No.
33-00088), filed September 5, 1985.
44
*10.10 AHS 1989 Stock Incentive Plan, previously filed and
incorporated herein by reference from AHS's Annual Report on
Form 10-K for the fiscal year ended December 31, 1990, filed
April 15, 1991.
*10.11 AHS 1992 Option and Incentive Plan, previously filed and
incorporated herein by reference from AHS's Registration
Statement on Form S-8 (Registration No. 33-51532), filed
September 1, 1992.
*10.12 MHC 1989 Stock Option Plan, Amended and Restated as of October
28, 1993, previously filed and incorporated herein by reference
from MHC's Annual Report on Form 10-K for the fiscal year ended
December 31, 1993.
*10.13 Letter Agreement for Consulting Services between InSight and
Frank E. Egger dated March 28, 1996, previously filed and
incorporated herein by reference from the Company's
Registration Statement on Form S-4 (Registration No.
333-02935), filed April 29, 1996.
*10.14 Executive Employment Agreement between InSight and E. Larry
Atkins dated as of February 25, 1996, previously filed and
incorporated herein by reference from the Company's
Registration Statement on Form S-4 (Registration No.
333-02935), filed April 29, 1996.
*10.15 Executive Employment Agreement between InSight and Glenn P.
Cato dated as of May 1, 1996, previously filed and incorporated
herein by reference from the Company's Amendment No. 1 to the
Registration Statement on Form S-4 (Registration No. 333-
02935), filed May 9, 1996.
*10.16 Form of Executive Employment Agreement between InSight and
various officers of InSight, previously filed and incorporated
herein by reference from the Company's Registration Statement
on Form S-4 (Registration No. 333-02935), filed April 29, 1996.
*10.17 Nonqualified Stock Option Agreement, dated August 17, 1994,
between MHC and Leonard H. Habas, previously filed and
incorporated herein by reference from the Company's Annual
Report on Form 10-K for the six months ended June 30, 1996.
*10.18 Nonqualified Stock Option Agreement, dated August 17, 1994,
between MHC and Ronald G. Pantello, previously filed and
incorporated herein by reference from the Company's Annual
Report on Form 10-K for the six months ended June 30, 1996.
10.19 Warrant Certificate No. S-1 dated August 14, 1996 in the name
of Shattuck Hammond Partners, Inc., filed herewith.
10.20 Warrant Certificate No. L-1 dated March 11, 1997 in the name of
Anthony J. LeVecchio, filed herewith.
10.21 Form of Stock Option Agreement between InSight and non-employee
directors of InSight relating to InSight's 1996 Directors' Stock
Option Plan, filed herewith.
10.22 Form of Stock Option Agreement between InSight and employees of
InSight relating to InSight's 1996 Employee Stock Option Plan,
filed herewith.
21 Subsidiaries of InSight, filed herewith.
* Previously filed.
45
ITEM 14(b). REPORTS ON FORM 8-K. The Company filed a Current Report on
Form 8-K with the Securities and Exchange Commission on June 19,
1997, under Item 2 thereof, reporting the acquisition of Maine
Imaging Consortium.
ITEM 14(c). The Exhibits described above in Item 14(a)(3) are attached
hereto or incorporated by reference herein, as noted.
ITEM 14(d). Not applicable.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
INSIGHT HEALTH SERVICES CORP.
By /S/ E. LARRY ATKINS
------------------------------
E. Larry Atkins, President and
Chief Executive Officer
Date: October 14, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ---------- ------- ------
/s/ E. LARRY ATKINS Director, President and October 14, 1997
- -------------------------- Chief Executive Officer
E. Larry Atkins (Principal Executive Officer)
/s/ THOMAS V. CROAL Executive Vice President and October 14, 1997
- -------------------------- Chief Financial Officer
Thomas V. Croal (Principal Accounting Officer)
/s/ GRANT R. CHAMBERLAIN Director October 14, 1997
- --------------------------
Grant R. Chamberlain
/s/ DAVID W. DUPREE Director October 14, 1997
- --------------------------
David W. Dupree
/s/ FRANK E. EGGER Director October 14, 1997
- --------------------------
Frank E. Egger
/s/ LEONARD H. HABAS Director October 14, 1997
- --------------------------
Leonard H. Habas
/s/ RONALD G. PANTELLO Director October 14, 1997
- --------------------------
Ronald G. Pantello
/s/ GLENN A. YOUNGKIN Director October 14, 1997
- --------------------------
Glenn A. Youngkin
47
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To InSight Health Services Corp.:
We have audited, in accordance with generally accepted auditing standards,
the financial statements for INSIGHT HEALTH SERVICES CORP. included in this
Form 10-K and have issued our report thereon dated October 14, 1997. Our
audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in the index to consolidated
financial statements is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. The schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required
to be set forth therein in relation to the basic financial statements taken
as a whole.
ARTHUR ANDERSEN LLP
Orange County, California
October 14, 1997
48
SCHEDULE IX
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED JUNE 30, 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
(amounts in thousands)
Balance at Charges to Balance at
Beginning of Cost and End of
Period Expenses Other Period
------------ ----------- --------------- -------------
December 31, 1994:
Allowance for doubtful accounts $ 1,664 $ 1,124 $ (1,233)(A) $ 1,555
Allowance for contractual adjustments 1,030 2,692 (2,384)(A) 1,338
Inventory reserve 830 - (830)(B) -
---------- --------- ---------- -----------
Total $ 3,524 $ 3,816 $ (4,447) $ 2,893
---------- --------- ---------- -----------
---------- --------- ---------- -----------
December 31, 1995:
Allowance for doubtful accounts $ 1,555 $ 1,669 $ (1,489)(A) $ 1,735
Allowance for contractual adjustments 1,338 4,512 (4,302)(A) 1,548
---------- --------- ---------- -----------
Total $ 2,893 $ 6,181 $ (5,791) $ 3,283
---------- --------- ---------- -----------
---------- --------- ---------- -----------
June 30, 1996:
Allowance for doubtful accounts $ 1,735 $ 617 $ (63)(A)(C) $ 2,289
Allowance for contractual adjustments 1,548 3,440 531 (A)(C) 5,519
---------- --------- ---------- -----------
Total $ 3,283 $ 4,057 $ 468 $ 7,808
---------- --------- ---------- -----------
---------- --------- ---------- -----------
June 30, 1997:
Allowance for doubtful accounts $ 2,289 $ 1,506 $ (1,453)(A) $ 2,342
Allowance for contractual adjustments 5,519 17,483 (17,853)(A) 5,149
---------- --------- ---------- -----------
Total $ 7,808 $18,989 $(19,306) $ 7,491
---------- --------- ---------- -----------
---------- --------- ---------- -----------
(A) Write offs of uncollectable accounts.
(B) MHC sold all inventory on hand in 1994.
(C) In connection with the Merger, MHC acquired the valuation and
qualifying accounts related to IHC.
49